According to government data, the Australian economy has been sluggish for some time now. The Reserve Bank of Australia (RBA) has cut interest rates 3 times this year to historic lows in an effort to improve the rate of growth in our economy. More recently, the RBA announced that they are considering alternate strategies to prevent the economy from slipping, one of which is known as a negative interest rate.
But let’s take a step back.
Firstly, cash rates announced by the RBA affect the interest rates given by your bank for savings and loans. A low cash rate generally means lower interest rates.
A lower interest rate means a lower rate of return for people who have savings or term deposits at the bank and are hoping to generate as much income as possible from their money. For example, if I have $100 and the current interest rate is 2.5% per annum, I would end up earning 2.5% on my original balance, leaving me with $102.50. Back in 1990, deposit interest rates were around 15%, so my $100 would have turned into $115.
On the other hand, lower interest rates are good for people who borrow money from the bank, as they don’t need to pay as much extra interest on their debt.
What is a negative interest rate?
A negative interest rate is when the interest rate goes below 0.
When this occurs, those people who have savings at the bank will actually lose money. Or put another way, you are paying for the security of a bank to hold your money.
Your $100 in the bank will be worth just $99 with a -1.0% negative interest rate.
Why does a negative interest rate happen?
In Australia, cash rates are dictated by the RBA as they are responsible for setting monetary policy. If the economy continues to struggle, the RBA may choose to move to a negative interest rate in an effort to improve economy growth.
How does a negative interest rate improve the economy you ask? Well, having your money saved means you won’t be spending it, and the less people spend, the slower the economic growth. Not having to pay any interest on your loan means you’re freeing up people’s cash to encourage spending and thus a healthier economy.
When is this likely to happen?
The RBA hasn’t specified when this might happen, they have merely hinted that it could happen. RBA governor Dr Philip Lowe recently said, “It’s possible that we end up at the zero lower bound. I think it’s unlikely, but it is possible. We are prepared to do unconventional things if the circumstances warranted it.”
Negative interest rates have never occurred in Australia but some central banks in Switzerland and Japan have set interest rates below zero. Strange times indeed.
What should investors do?
- Invest in asset classes that deliver an acceptable rate of return relative to the risk taken.
- Do not have any more cash than needed.
- Shop around for the best rates.
For all our clients, we will continue to keep a close watch on market movements to ensure your financial plan can withstand any hits and punches.
What Can Align Financial Do For You? Visit our homepage to learn more about our service. If you would like to speak to us about your financial circumstance, please feel free to give us a call on 02 9913 9995. We are located in Narrabeen on the Northern Beaches of Sydney.
Disclaimer: This post has been prepared for general information purposes only. It is not specific advice to any particular person. You should consult an authorised Align Financial adviser before making financial decisions. Align Financial | Financial Planner Northern Beaches | Servicing North Narrabeen, Narrabeen, Mona Vale, Elanora Heights, Newport, Avalon, Palm Beach | Enquire with us online