What the rate cut means for you

December 4, 2012, 2:44 pm David Koch Yahoo!7

Unfortunately for borrowers it's likely to be a similar story to what we’ve seen over the course of 2012, where lenders have held back about a third of all rate cuts.

The Reserve Bank has cut the official cash rate by 0.25% today in response to weak retail spending, creeping unemployment and further contractions in business spending and manufacturing.

Monday's poor company profits and job ad figures were just further proof of the slowing economy.

And with inflation comfortably within the RBA’s target band of 2% to 3%, there really was no reason not to provide some relief, bringing the cash rate back to its lowest level since the depths of the financial crisis three years ago.

So that’s the why. But what does it mean for you and how much of the cut can borrowers and depositors expect to see?

Unfortunately for borrowers it’s likely to be a similar story to what we’ve seen over the course of 2012, where lenders have held back about a third of all rate cuts.

While this is far from ideal for borrowers, banks have reason to be holding back a bit of the relief as wholesale borrowing costs remain inflated.

You see, over the course of the year international lenders have been pulling their money out of offshore money markets to steady balance sheets at home, thereby raising borrowing costs.

Unfortunately they still haven’t come back to the market in any meaningful way and as such banks remain very careful.

So while today’s rate cut is great news for borrowers and businesses, don’t get too excited until the banks move as it’s probably not going to be passed on in full.

That said, the competition amongst smaller lenders continues to hot up with the recent tie up of Yellow Brick Road and Macquarie Bank only increasing the number of options available.

In such a competitive lending market there's no way you should be paying the advertised variable rate, so if you are then ask for a discount today.

But don’t necessarily splash out any savings you make from today’s cut or any loan switch you might make. If you’re in a position to maintain repayments on borrowings, whether a mortgage or a personal loan, I can’t advise strongly enough to do so.

Resist the temptation to pocket the windfall and knock off a bit more debt instead, ideally through an offset account so the money is still there should anything financially untoward crop up.

While banks haven't passed on the full rate cut to borrowers in the past, they haven't cut savings rates by as much either. In fact savers have been the winners with banks more generous to them than borrowers.

Still, any reduction in deposit rates is tough on retirees and investors relying on interest payments to get by and wanting to avoid the volatile equity and debt markets.

But if you look around financial institutions still want your cash and to secure new customers are offering some enticing introductory rates, even while existing customer rates are wound back.

So if you’re in the depositors boat, depending on how hard banks move on savings accounts this time around, it’s worth looking out for a better deal. Smaller lenders, which rely more heavily on retail deposits, are especially worth asking.

The other implication of deposit rates falling further today is a likely shift of investors from cash to yield, or dividend paying, investments.

It’s been widely touted that the next rate cut could be the last straw for a lot of investors holding cash, so if this proves true and a swell of money seeks a better return elsewhere we can expect good yielding stocks and fixed income investments to be in hot demand.

If you’re in this boat, whether investing retirement savings or a personal portfolio, don’t get swayed by the herd.

A careful and considered reallocation of investments is a safer move than a complete change in strategy. And, as always, seek proper financial advice.

As I’ve said before, if your financial institution isn’t giving you the best deal, look around and ask them why. This isn’t just advice for mortgagees but savers too.

And with the RBA not meeting again until February now (yes they have summer holidays too) it’s an especially good time to review your interest rate bearing borrowings and investments to take advantage over the extended period of local banking calm.

But events abroad, as always, could seriously rock the boat and we'll be watching the US fiscal cliff very closely over the New Year so stay tuned.

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