What are the underlying causes of the ongoing low interest rates and what is likely to happen in the future?
27 October 2021.
We know the ongoing low rate environment has made the prospect of sufficient returns difficult for many income focussed investors, including those in the Cash Management Trust. But what are the underlying causes of the ongoing low rates and what is likely to happen in the future?
Why are rates so low?
The interest rates banks offer on deposits are impacted by the cash rate set up by the Reserve Bank of Australia (RBA). The Cash Management Trust holds a mix of cash and term deposits.
The RBA sets the cash rate to influence what is happening in the economy and it is set after consideration of a range of factors. The factors can include economic growth, unemployment rates, inflation and the level of money supply (liquidity).
Even before the global economic impact of COVID-19 the cash rate has been steadily declining. In June 2011, the cash rate stood at 4.75% ― while at the beginning of 1990, it was sitting at 17.50%.
The cash rate now? It’s just 0.10%.
How did we get to this point?
Generally, the RBA sets the cash rate lower hoping that people will spend less on interest payments and more on consumption. The RBA also wants to hit their inflation target of between 2% and 3%, which means our economy is growing at their preferred rate and the country is financially stable. This has become increasingly important to counter the effects of economic slowdown coming from COVID-19.
How does this relate to the Cash Management Trust (CMT)?
As the CMT consists solely of cash and term deposits, the rates offered by banks directly influence the investment returns which can be achieved. With the RBA setting a record low rate and ensuring that there is excess money supply in the economy (to stimulate growth) there is less need for banks to offer higher interest rates to attract depositors.
As the rates offered by banks and deposit taking institutions have reduced across term deposits and interest bearing accounts, this has reduced the investment return of the retail CMT, which delivered a net return (after fees) of 0.1% in FY21. While there are some indications that we’ll see an increase in the rate of return for the 6 months until December 21, any gains will be modest.
What does the future hold?
The economic outlook is still uncertain as the global pandemic progresses through another year. We can only hope that as vaccine use proliferates and treatments improve, the pandemic if brought under some semblance of control. Hopefully sooner rather than later. It is inevitable that the rate cycle will change, and an increase in the RBA cash rate will see a flow on to greater yields from term deposits.
Regardless of the future, U Ethical is focussed on delivering value to our clients and will endeavour to maximise low-risk returns.
Want more Good Returns news?
Subscribe to receive the latest ethical investment news.