How low will the RBA go?

Co-founder of the Switzer Report
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The interest rate bulls are running hard. The market is factoring in two further easings by the Reserve Bank of Australia (RBA) by March, a third by June and a fourth by December 2012. This would take the cash rate down to 3.25% by year’s end – a big change from the 4.75% cash rate the RBA stubbornly held onto for most of 2011.

Somehow, I just can’t see this sort of change.

More cuts?

The interest rate bulls are driven by the expectation that the Euromess will continue to make liquidity very tight, and as fiscal stimulation is off the political agenda, the RBA will be forced to aggressively lower interest rates.

While a further easing of 0.25% in February or March is probably on the cards, renewed enthusiasm for the strength of the US economy, together with ongoing Australian wage inflation and concerns about a weak minority government, will temper the RBA’s hand. Moreover, a leopard doesn’t change its spots that quickly, and while the RBA listened to the manufacturing and retail lobby (and the market) at the end of 2011, it’s not about to go overboard.

When will the hikes start?

If anything, I think we will see interest rates on the rise by the end of 2012.

Government Treasury bond rates have continued to fall – three-years are down to 3.25%, five-years to 3.4% and 10-years to 3.85%. The government bond/bank bill yield curve kinks at around the one-year mark – that is, it is downward sloping out to 12 months (reflecting expectations of further RBA easings), before taking on a more normal upward sloping shape as the maturity lengthens. As the banks price their term deposits off this curve, the term deposit market follows suit. The latest term deposit rates are as follows:

As I mentioned, I think we will be seeing rates on the increase before year’s end – probably in the third quarter. However, there is an easing or two to get through first. Now is not the time to be locking in for long terms.

In the term deposit market, there are some reasonably attractive rates on offer in the six- to nine-month part of the curve – ING’s 6% for six months or UBank’s 6.11% rate really stand out.

Deposits of up to $250,000 per investor, per bank are government guaranteed – so it makes up for the effort of opening another account. The major banks can probably be squeezed, so a rate of 5.6% should be readily achievable.

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