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What the rate cut means for self-funded retirees

It was little surprise to anyone that the Reserve Bank of Australia cut the cash rate at its August 2016 board meeting. It’s at a record low – and while borrowers welcomed the cut, savers who have their money in cash products are negatively affected, especially self-funded retirees.

There have been 12 rate cuts since 2011, and as a result, keeping savings in cash products such as term deposits is becoming less and less attractive. Because of this, retirees need to take on more risk to earn a decent income, usually at a time when they want to be in safe, conservative investments.

Around 2 million Australians fund their own retirements – either fully or partially – with many relying on term deposits for their income. In a surprise move, while the big banks cut their mortgage rates following the RBA announcement, they also raised rates on term deposits of between one to three years to around 3%.

 

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The Australian Bankers’ Association CEO Steven Munchenberg said this rise in term deposit rates is great news for many Australians. “Particularly seniors who rely on their savings in retirement and are being squeezed by low interest rates,” he said. “At the same time, those Australians with a mortgage continue to enjoy the lowest rates in over 50 years.”

While many Self-Managed Superannuation Fund (SMSF) investors use term deposits, the rates are still very low, making it difficult to generate a sustainable income. Riskier products such as hybrids, bonds and shares are being considered in the search for yield.

The search for yield in riskier investments is being exacerbated by retirees who draw a private pension, as they are forced to withdraw capital in order to meet the pension rules. These rules state that retirees must drawdown a minimum of between 4% and 14% from their pension account each year, depending on their age.

 

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Why did the RBA cut rates?

The majority of economists surveyed prior to the RBA’s meeting forecast a rate cut of 0.25 basis points and that’s what we got. The rate now sits at 1.5%, a record low.

But why, with rates at historical lows, did the RBA feel the need to cut again?

Economists had been stressing the high Australian dollar, which appears resistant to falling, along with the weak June quarterly inflation figure, would lead to the RBA cutting again. Inflation rose 0.4% in the June quarter and 1% through the year to the end of June. The RBA’s target inflation range is between 2%-3%.

Economist Shane Oliver said the latest rate cut is all about adding to confidence that inflation will head back to the 2-3% target zone within a reasonable time and to help maintain downwards pressure on the value of the Australian dollar in the face of ongoing delays in US Federal Reserve rate hikes.

“The RBA is trying to prevent a further fall in inflation expectations that could push wages growth to new record lows and make it even harder to get inflation back to target,” he said. “The longer inflation remains low and below target the greater the risk that it will become entrenched as we have seen in several other developed countries in recent years.”

 

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RBA governor Glenn Stevens outlined a number of reasons why he cut the rate. From the RBA’s statement, it appears Stevens is not as concerned about lower rates sparking more growth in the housing market – which has been a key concern for months. In his statement he referred to the recent supervisory measures that have tightened lending standards.

“The most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with a considerable supply of apartments scheduled to come on-stream over the next couple of years,” he said. “Growth in lending for housing purposes has slowed a little this year. All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished.”

The RBA believes stronger economic growth is needed to lift inflation back into its target range of between 2% – 3%.  If core inflation stays below this target, more rate cuts may be on their way, posing increasing dilemmas for self-funded retirees needing to fund their cost of living.

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Gayle Bryant

Gayle has been a financial and business journalist and sub-editor for almost 30 years. She has written for a wide range of newspapers, magazines, custom and trade press and websites. Gayle’s articles regularly appear in the Sydney Morning Herald’s small business section and the Australian Financial Review’s special reports section.

The opinions expressed in this article are the opinions of the author(s) and not necessarily those of Homeloans Ltd.