A progressive capital solution for Australia’s interest rate uncertainty

After increasing interest rates 12 times in the 13 months to June 2023, Australia’s central bank has been keeping the markets guessing as to its next move.

The Reserve Bank of Australia (RBA) held interest rates at 4.1% at monetary policy meetings in July, August and September. Though the RBA warned further hikes may still be on the cards, it also indicated that it would wait to assess the full impact of its hikes to date before committing to further tightening – especially in light of a recent decline in inflation and slight rise in unemployment.^[1]

A majority of economists polled by Reuters expect there will be a further hike in November, taking the cash rate to a 12-year high of 4.35%. Meanwhile, three of the nation’s four biggest lenders say there will likely be no further hikes beyond the current position – a level they believe is sufficient to cool inflation and achieve a soft landing.^[2]

One of the main reasons the RBA has adopted a more cautious approach to tightening than central banks in other comparable countries is that most Australian mortgage holders are on variable rate loans, whereas in places like the US, fixed rate loans with terms as long as 30 years are the norm.^[3] This means the impact of higher rates filters through much faster in Australia, placing a burden on consumers and curtailing spending – which, in turn, should help curb inflation.

And clearly, the interest rate is already high enough to inflict pain on consumers, placing growing pressure on businesses. Until now, however, business confidence has remained resilient, according to a survey by National Australia Bank, even though a separate survey by Westpac Banking Corp. revealed consumers have grown “deeply pessimistic.” ^[4] Data from Equifax also indicates a rising trend of missed mortgage payments.^[5] In time, businesses too will feel the pain as sales and profitability slide further.

In this climate, progressive capital solutions like securities-based financing from EquitiesFirst could be especially attractive, providing investors a relatively low-cost, fixed-interest-rate loan.

Equity investors see more pain ahead

Unemployment will need to increase before inflation is brought to heel, according to the head of equities at an Australian pension fund interviewed for a landmark study on the outlook for global equities, conducted by EquitiesFirst in collaboration with Institutional Investor.

High interest rates will also drive up financing costs, resulting in earnings downgrades in Australia and elsewhere in Asia, according to sources interviewed for the report.

The RBA will be keeping a close eye on this, as well as inflation trends, consumer spending, labour costs and business surveys, to determine whether further hikes are prudent.

Although the market remains divided on whether Australia’s rate hiking cycle would come to an end, significant cuts are unlikely soon given the country’s core inflation, at around 6%, is well above the RBA’s target of 2-3%. The central bank has said it does not expect inflation to return to its target range until late 2025.^[6]

Moreover, the RBA cautioned that inflation could prove more persistent than forecast if wage growth is stronger than expected or productivity growth fails to recover.^[7] Australia is also due to implement legislated tax cuts, mainly directed at higher income earners, next year, which could provide an economic stimulus from mid-2024, maintaining pressure on prices.^[8] Analysts point out that these factors make it not inconceivable that the RBA could extend tightening until 2025.^[9]

Securities-based financing helps fill the gap left by the credit crunch

Companies may require infusions of working capital to cope with these near-term headwinds, but they, too, are faced with high interest rates and tight liquidity conditions.

A compelling financing solution is a securities-backed loan from EquitiesFirst. These funds can be used by investors for any purpose, including personal investments and funding company operations.

When interest rates are high and liquidity conditions are tight, securities-backed financing can be especially valuable for investors, allowing them to diversify their holdings without sacrificing the upside potential of their underlying holdings.

The EquitiesFirst x Institutional Investor report reveals that investors focused on Australia are far more concerned about commodity prices than those in other regions. This is not surprising given that commodities have an outsized influence on the local economy and currency.^[10]

Given the uncertainty about the outlook for Australia’s interest rates and its economy, it might be a good time for Australia-focused investors to hedge and diversify.

[1] https://www.reuters.com/markets/rba-hold-rates-410-tuesday-will-hike-again-next-quarter-2023-09-01/

[2] https://www.reuters.com/markets/rba-hold-rates-410-tuesday-will-hike-again-next-quarter-2023-09-01/

[3] https://www.ratecity.com.au/home-loans/mortgage-news/news-why-australian-dollar-low-here-s-interest-rates-affect-dollar

[4] https://www.bloomberg.com/news/articles/2023-08-08/australian-consumer-sentiment-slips-as-price-pressures-mount

[5] https://www.bloomberg.com/news/articles/2023-08-01/australia-extends-rate-pause-for-second-month-currency-drops

[6] https://www.reuters.com/markets/rates-bonds/australian-central-bank-holds-rates-steady-second-month-2023-08-01/

[7] https://www.rba.gov.au/publications/smp/2023/aug/overview.html

[8] https://www.abc.net.au/news/2023-08-04/rba-statement-monetary-policy-inflation-interest-rates-economy/102688084

[9] https://www.reuters.com/markets/rates-bonds/australian-central-bank-holds-rates-steady-second-month-2023-08-01/

[10] https://www.abc.net.au/news/2023-08-08/australian-dollar-hibernation-commodities-interest-rates-economy/102697018

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