When will interest rate cuts happen? Seemingly they will occur this year, although there is a disconnect between when investors believe and hope for and what central banks (particularly the RBA) are implying.
The RBA has lifted interest rates from 0.1% in April 2022 to 4.10% by June 2023 and a further 0.25% hike came in November to 4.35% to tackle inflation. But what comes up must come down right? After all, inflation is gradually coming down and the RBA does not want ‘deflation’ to occur. The latest word from the RBA poured cold water on hopes that ‘the job is done’.
The RBA in 2024
The RBA has a new governor in Michele Bullock and is only meeting 8 times a year instead of every month. Crucially, the meetings will occur around the times of key economic data enabling them to make better decisions and press conferences will be held afterwards, rather than just a statement posted to the bank’s website.
A statement still was posted, however, and it started by telling us what we already knew, that inflation was moderating and was high. Inflation was expected to return to the 2-3% target range in 2025. The bank noted that returning inflation to this range was its highest priority.
‘The Board needs to be confident that inflation is moving sustainably towards the target range – to date, medium-term inflation expectations have been consistent with the inflation target and it is important that this remains the case,’ it said.
‘While recent data indicate that inflation is easing, it remains high. The Board expects that it will be some time yet before inflation is sustainably in the target range’.
When will interest rate cuts happen?
Judging by that statement, don’t expect any cuts until inflation is within the target range – so maybe not until 2025 or late this year at the earliest. The bank learned its lesson from saying ‘no rate hikes until 2024’, with Phillip Lowe being heavily scrutinised when he broke that promise until his eventual departure.
Looking to other views, bond trading implies the probability of a first rate cut in June is 46%, but at least one rate reduction this year is fully priced in.
Economists from Westpac and CBA predict the first rate cut in September, while NAB believes it will be in December. CBA is forecasting a 2.85% cash rate in June 2025, CBA 3.1% by September 2025 and NAB 3.1% by 2025.
Ultimately, we think this isn’t too unreasonable an expectation, but forget about them if inflation isn’t in the 2-3% range. We are worried that the Stage 3 tax cuts could potentially add to inflation when they commence in July this year.
So what will it mean for stocks?
We’ve covered the broader question of how interest rates impact stocks in greater detail here. To summarise here, interest rate cuts will:
- Make equities more appealing as an asset class
- Reduce higher borrowing costs for companies in stocks
- Impact company valuations
The second is blatantly obvious, although not all companies in debt will derive the same benefit.
When interest rates are low, investors are more likely to invest their capital in stocks because there is less reward available from other investments such as bonds and cash. Low interest rates make stock investing attractive due to the potential for higher returns.
However, when rates increase, stocks may become less attractive to investors since they offer comparatively lower returns. Of course, there will always be stocks that go up when interest rates are higher and those that go down when interest rates are lower.
Rates may also increase company valuations for a number of reasons, including lowering the discount rate in the DCF model or lowered borrowing costs factored into a company’s forward earnings.
While mortgage holders will inevitably be watching interest rate calls closely, so should stock investors, because they could be impacted just as significantly.
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