With cash deposits offering unattractive returns risk averse investors could be forgiven for wanting interest rates to rise. So does the decision by the Reserve Bank of Australia (RBA) to raise the base interest rate by 0.25% to 3.25% signal the beginning of a trend?
The situation down-under
Central banks are now generally focused on when base rates should be increased and the monetary stimulus cut. However the RBA’s decision on the 6th October was a surprise and it makes Australia the first country in the G20 to increase interest rates following the recent economic crisis. The Governor of the RBA Glenn Stevens predicted that ‘growth (is) likely to be close to trend over the next year ahead, (and) inflation close to target’.1 This is a bullish assessment of the Australian economy but not necessarily unrealistic.
Australian inflation, as measured by the Consumer Price Index (CPI) as a percentage change year on year (YoY), appears steady but the quarterly change figures show growth over the last two periods with quarter 3 expected to show further increases.
Australia’s fiscal position is also relatively attractive despite the fact that household indebtedness in Australia is only marginally below the UK and US. The government also runs a considerable budget deficit. However huge commodity exports to China, equalling 11.5% of Gross Value Added (GVA) and increasing, have helped provide a solid medium term position. The significance of this is that Australia was able to afford a large fiscal stimulus.
Source: IMF Staff Report on Korea July 2009.
Crucially, as Australian banks did not buy or sell ‘toxic’ assets, this stimulus was targeted at the real money economy and not banks. In contrast the UK government currently owns roughly 25% of the liquid gilt market between redemptions 5 and 25 years – a figure that is likely to increase. One such policy that the Australians were able to utilise was large-scale support for first time buyers which has helped support Australian house prices. From their cyclical highs Australian house prices have fallen only 2.2%, in the UK this figure is 13.5%.2 The positive fiscal and monetary outlook for Australia underlines why they have been the first G20 country to increase interest rates, in order to diffuse potential asset bubbles.
Will Britain follow this trend?
The UK economy compares unfavourably to Australia. The specific area of concern is in consumer spending; a key consideration for monetary policy. The UK’s Monetary Policy Committee’s (MPC) meeting minutes for September they remained cautious, stating, ‘Growth in private final demand, which is essential for a sustained recovery, had been weaker in 2009 Q2 than the MPC had expected at the time of the August Inflation Report.’ 3 Figures released from the Office of National Statistics supports this point. Household saving, as a percentage of disposable income, rose from 1.7% in 2008 to 5.6% in Q2 2009.4 This situation is known as the king’s paradox, whilst the economy needs further investment in the long run it requires a consumer spending boost in the short term.
Such data underlines why we remain suspicious of consensus estimates for base rates in the UK. Over the next few months inflation in the UK, as measured by CPI, is likely to remain volatile and may increase from its current figure of 1.1% largely due to energy prices, statistical anomalies and January’s VAT increase. Over the medium term however, given the macroeconomic picture, we expect a reduction in inflation or deflation. Employment is down 1.8% over the year. Average earnings excluding bonuses grew by 1.9% YoY in the three months to August; this is the lowest ever recorded.5
All of these factors are powerful indicators of the UK’s future inflation. We believe that there will continue to be an increased margin between UK and Australian interest rates. 2.7% is the average current prediction for UK interest rates at the end of 2010. We expect half that.
Searching for a secure yield?
The conclusion for savers is clear; cash returns are likely to remain low and investors are being forced into riskier assets if they want to increase their income. Currently we prefer property for yield and some inflation protection and absolute return funds for some protection against the volatile times that may lie ahead. Although corporate bonds have made most of their capital gains yields nevertheless remain attractive. In these sectors we currently prefer SWIP Property, New Star Property and Gartmore European Absolute Return.
Regardless of the rates on offer, most investors will always want to keep some of their cash in low risk investments. To compare or get ideas on the different rates available please visit our new income rates page www.bestinvest.co.uk/investment-research/income-rates.
1 Media Release. www.rba.gov.au/MediaReleases/2009/mr-09-23.html
2 www.rba.gov.au/Statistics/measures_of_cpi.html
3 BCA Research.
4 www.bankofengland.co.uk/publications/minutes/mpc/pdf/2009/mpc0909.pdf
5 Office of National Statistics.