Christmas has come early for the bank’s shareholders with the decision to slightly increase the 2024 dividend – despite a single-digit decline in the net profit and cash earnings.
Beating the market benchmark is never easy, with 72 per cent of Australian actively managed global equity general funds trailing the S&P World Index in the six months to June 30, 2024. Domestic equity funds performed slightly better, albeit against a significantly lower bar set by the S&P/ASX 200 Index.
The rate hike was bigger than expected, what next?
Well, that was a surprise. A 50bps interest rate hike by the RBA wasn’t what anyone was expecting. In fact, 86 per cent of economists and analysts, such as AMP’s Shane Oliver and Saul Eslake, interviewed by Finder had their money on the RBA increasing the cash rate by 25bps. With this 50bps hike, it takes the cash rate to 85bps – well ahead of most economists’ expectations.
Looking at the statement issued by Governor Philip Lowe, it’s all inflation, inflation, inflation. Lowe points out that inflation in Australia has increased significantly, albeit lower than in other advanced economies, but higher than earlier expected. The rise coming from Covid related disruptions and domestic factors as well. Nonetheless, inflation is expected to rise further but fall back towards 2-3 percent next year. “Today’s increase in interest rates will assist with the return of inflation to target over time,” says Lowe.
Forecasts are for the cash rate to now hit 1.5 percent by year-end and 2.5 percent by the end of next year. The Board says it “expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”
What are the knock-on effects?
- Borrowing becomes more expensive
The big four banks source funds for their variable rate mortgage products from the RBA. The cash rate is the interest rate on unsecured overnight loans between the banks. When it goes up, it costs more for the banks to borrow money in the very short term. The banks usually pass on this interest rate rise to the customer. If passed on in full by the banks, the rate rise will add:
- $133 a month on a loan worth $500,000 over 25 years
- $265 a month on a loan worth $1 million
If the cash rate hits 1.0 percent by year end, it will add:
- $275 a month on a loan worth $500,000
If the cash rate hits 2.0 percent, it will add:
- $560 a month on a loan worth $500,000
If the cash rate hits 2.5 per cent by the end of next year, the rate rise will add:
- $652 a month by Christmas next year, on a loan worth $500,000
Because of today’s larger than expected rate rise, financial markets are even more aggressive, pricing in a 1 percent interest rate by October and a 2.0 percent cash rate by May next year.
2. Deposits start earning more
On the flip side, higher rates also mean higher interest paid out to depositors. So term deposits and savings accounts that are currently paying out a few dollars a year, will become a tiny bit more generous. More importantly, rising interest rates are a net positive for the big four banks as it bolsters their outlook. The last few years have been tough, because of increased competition in home lending amid record-low rates. With rising rates, it eases these pressures and helps bolster the bank’s Net Interest Margin (NIM).
3. Higher rates spell bad news for the property, stock and bond markets
The local equity market reacted almost instantly to rate rise. The ASX fell by 1.50 percent with traders reacting badly. At the same time, according to the AFR, three-year bond yields rose by 17bps to 3.15 percent and ten-year yields rose by 6bps to 3.55 percent. Bond prices move in the opposite direction to their yield. As yields increase, traders sell short term bonds to buy longer-dated bonds with higher yields. This causes bond prices to fall.
Finally, higher borrowing costs will have a knock-on effect with home prices. The RBA says, a 2-percentage point increase in interest rates could wipe 15 per cent from house prices. That’s a huge hit for those that have only recently bought properties at the top of the market. The RBA warning those that have recently taken out huge mortgages to start bracing for an increase in repayments.
And this is especially true for those on fixed-rate mortgages taken out during record low-interest rates. When these loans convert to variable-rate loans, the difference in monthly mortgage payments can cause large shocks.
Financial markets are even more aggressive, pricing in rates above 3.25 per cent by the end of 2023, just as Australians who took out fixed-rate mortgages in 2020 have to roll over into a new loan.
4. The Australian dollar strengthens
A side effect of higher interest rates is that it makes Australian dollar-denominated assets more attractive. The RBA says “Australia’s interest rate differential measures the difference between interest rates in Australia and those in other economies. All else being equal, an increase in Australian interest rates contributes to the exchange rate being higher than otherwise. If Australian interest rates increase relative to interest rates in the US, Europe or Japan, Australian assets that pay interest become more attractive to foreign investors.” When foreign investors buy more Australian assets, more money flows into Australia and the demand for Australian dollars goes up leading to an appreciation in the Australian dollar exchange rate.
