RBA chasing money out of the banks

December 5, 2012, 1:53 pm Michael Pascoe Yahoo!7

An interest rate cut is about more than just home loans. Low interest rates are also designed to get money out of savings accounts and into the broader economy.

Every official interest rate cut makes it a little bit easier to tell risk-adverse people that their money isn’t necessarily safe while on deposit in the bank – and that is one of the messages looser monetary policy is supposed to deliver.

The 30 per cent or so of Australian households with mortgages are the great noisy minority – it sometimes seems they are the only people here as far as the media and politicians are concerned when interest rates are mentioned. But there’s another large and largely silent tribe that is more likely to wince than smile when rates are cut. While the heavily indebted cheer each interest rate cut and want more, the savers, especially self-funded retirees, are delighted to have high deposit rates paid to them.

The Reserve Bank’s goal in cutting rates is to stimulate demand. In English, that translates into encouraging people to spend and invest more. What gets overlooked is that the “stimulation” comes in both carrot and stick form.

For people with plenty of debt, cutting rates can mean more money in their pocket each month as less is needed to service the mortgage. Thus they have more money to spend, which is what the retail sector hopes they will do.

For people with savings sitting in the bank, particularly those relying in regular interest payments for spending money, cutting rates has the opposite effect, reducing their spending power. But this is where the stick comes in.

It’s easy to leave cash in the bank when being paid what seems to be a high interest rate, but as the rates fall, the incentive to save lessens and the incentive grows to find something more productive and higher-yielding than bank accounts. Thus, in a roundabout way, the RBA is trying to chase some money out of the banks.

The search for yield has been a theme of the past year and will intensify as risk-free bank deposits become less attractive. And when deposit rates fall low enough, many retirees may find there is in fact a risk in being “risk free”. The trouble with money in the bank in a falling interest rate climate is that the capital is steadily being shrunk by whatever the inflation rate might be and the income it produces is shrinking as well. Even with our current low inflation rates, $100 deposited in a bank at the start of the year will really only be worth about $97 at the end of it.

Hence the importance of investments with capital growth potential as well as dividend yields – and there’s no easier example than the banks themselves.

As I write, the highest yield available on a bank deposit is 4.91 per cent from the NAB’s on-line brand, UBank, and that rate will soon fall. Let’s say it’s reduced to 4.7 per cent soon enough – and that’s before tax.

Also as I write, NAB shares are trading are trading at $24.26. The dividend of $1.80 over the past year means a yield of 7.4 per cent – but the dividend is fully franked. Adding on the franking credit means the pre-tax yield is a whopping 10.5 per cent.

Just from the dividend point of view, that is a massive incentive to be a shareholder rather than a depositor.

What scares people is that the share price can rise or fall, but such a big difference in yield can absorb part of the risk of a fall, while the ability of a solid portfolio of stocks to increase in capital value over time provides upside to the investment that a bank deposit does not.

From the point of view of someone needing dividends to live on, the share price doesn’t really matter as long as the dividends are sustained. And what’s likely to happen in the months ahead is that the search for yield is likely to support the price of solid high-yielding shares.

More from Michael Pascoe:
Forget Europe and the US, start worrying about Japan
Australia's stronger immigration - the other inflation dampener
States and retailers fooling themselves over GST

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6 Comments

  1. S01:10pm Friday 14th December 2012 ESTReport Abuse

    Financial oppression is about forcing and suckering people out of cash and buy into low quality, over priced dud investments. As always this is where the public will pile into property & shares, then lose out as interest rates shoot up from the low point while capital prices plunge with rising rates. This is the secret why the rich gets richer and the poor gets poorer- nicely dressed up as "Gini coefficient". The public buy in at careless prices under lowest rate (only time they can afford it) before prices / returns plunge under rising interest, whilst the rich buy in at the highest points of the interest cycle (only they can afford it) at the cheapest prices and enjoy capital growth as interest rates come down.

    Reply
  2. Grant01:57pm Thursday 06th December 2012 ESTReport Abuse

    This also has the effect of lowering income to those who depend on interest such as many retires, reducing their spending.

    Reply
  3. Ivan B09:25pm Wednesday 05th December 2012 ESTReport Abuse

    When I took my first mortgage in 1976, it very soon increased to 17.5 % !!! So I don't give a rats #$%$ about any young family whingeing today about 3% cash/mortgage rate. Also, In those days when my first baby was born , we have got nothing from the goverment, no 5000 bucks Centrelink reward like they are receiving nowadays. As for my self funded retirement, I have to suffer low interest yields, watching my fund to slowly disintegrate. My only consolation is that I dont have to go out and look for some kind of low paid job anymore ....

    2 Replies
  4. Lucky05:29pm Wednesday 05th December 2012 ESTReport Abuse

    ONE MORE .......The 30 per cent or so of Australian households with mortgages are the great noisy minority ,,,,,,,,,, people will not like this .....beware what are you caling people ,PASCOE ,,,, BE NICE OR DO NOT WRITE HERE

    Reply
  5. Lucky05:26pm Wednesday 05th December 2012 ESTReport Abuse

    HI TO ALL GOOD PEOPLE HERE

    Reply
  6. Lucky05:23pm Wednesday 05th December 2012 ESTReport Abuse

    All banks cut again interest only 0.20,,,,,,,,, Banks are criminals same as this govt ,,,, And about this story ,,,,Pascoe , 7.4 dividend from NAB IS GOOD BUT IF BANKS SHARE PRICE GOES DOWN YOU LOSE ,,, ONLY DIVI IS nothing ,,,,,, please if you canm go back to schoo, and i will join you in english class,,,,,,, Lucky is bad in english , you are bad in math

    1 Reply

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