How an increase in interest rates impacts your investments

May 25, 2022 | Debt, Investment, Property, Reflection, Shares

In last month’s blog I talked about inflation and the upcoming release of the Australian Bureau of Statistics (ABS) figures on 27 April. The figures released showed that over the twelve months to the March 2022 quarter, the consumer price index (CPI) rose 5.1%. The major influences were new home builds and fuel increases. The full release can be found here and some of the movements make for interesting reading.

A week or so later the Reserve Bank of Australia met and decided to increase the cash rate by 25 basis points to 35 basis points (0.35%). This was the first increase since November 2010 when the target cash rate increased from 4.50% to 4.75%. The last time the cash rate was at 1.0% was September 2019.

What will the interest rate hike do?

At a first glance, the interest rate hike might not do much. But with further interest rate increases expected, the cost of borrowing increases. As a result, the amount of borrowing decreases. It also means households are encouraged to save more and the interest rise means they may have increased loan repayments.

All this results in decreased spending. Given the supply/demand relationship, prices drop which in turn mean it reduces inflation.

Obviously, that is a very quick and overly simplistic explanation. Yet it is the RBA’s intent to lower inflation and bring it back to the 2-3% target with the help of increased interest rates. They hope to see this in a not-too-distant future.

Inflationary pressures are not solely being felt in Australia. US and the UK are having inflation at 40- and 30-year highs respectively and interest rate increases are also being made. Supply chain issues due to Covid-19 are adding fuel to the fire, along with the Russia-Ukraine war. Considering all this it is possible the RBA will increase again at their June meeting.

What do the interest rate increases mean to your investments?

Interest rate increases will affect different investments in different ways. Cash monies will start to earn more albeit minimally at the moment. Bond prices tend to fall in a rising interest rate environment as newer bonds pay higher interest rates and have more demand than the older bonds.

Borrowing will become more expensive with rising rates coupled with less demand to borrow means property assets can be affected negatively.

What happens with shares is less certain and there are many factors at play. Australian shares rose between 2003-2007 as interest rates increased, and we are coming off an historical low base.

The US Federal Reserve meet in June and may make another interest rate rise and whether their decisions can reduce inflation without tipping the economy into a recession may determine the direction of equity markets and whether there are more falls or not.

So what can you do?

For now, make sure you have a plan, stick to your asset allocation, consider rebalancing and keep a long term focus.

Simon,
Financial Advisor and Founder – Core IFA

About the author

Simon Duigan is an Independent Financial Advisor and owner of Core Independent Financial Advice (Core IFA). Core IFA is proud to be the first and only Tasmanian business to be approved by the Profession of Independent Financial Advisers (PIFA). This means Core IFA is independent and receives no commissions or benefits from any product providers or financial institutions. Instead, you can be confident that Core IFA have your best interests at heart.

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