There is increasing speculation that the Reserve Bank of Australia (RBA) could cut the cash rate next week from 1.5% to 1.25%. What would this mean for ASX investors and the big banks?
What Is The Cash Rate?
The RBA describes the cash rate on its website as, “the overnight money market interest rate.” Put simply, this is the interest rate that banks pay on the money they borrow overnight to settle outstanding transactions.
Lower Rates Would Hurt the Banks
Australian banks, particularly the big four banks, would be hurt by lower rates. A cut to the official cash rate could reduce profit margins and lending capacity of National Australia Bank Limited (ASX:NAB), Commonwealth Bank of Australia Limited (ASX:CBA) and others.
NAB has already announced a reduction in dividends earlier this week. Any negative force on profit margins would have the potential to push dividends even lower.
One option that the Australian Prudential Regulation Authority (APRA) is considering is a cut to the minimum serviceability rate used when assessing consumers for home loans. They are reportedly considering cutting the rate from 7.25% to 6.5%.
This would allow more consumers to qualify for a home loan and would also increase the maximum size of the loan they could receive.
While some people, like Shayne Elliot, CEO of Australia and New Zealand Banking Group (ASX:ANZ), think this would support falling house prices and is necessary to boost the economy, others believe this type of cut promotes irresponsible lending and is not a suitable long-term solution.
Are You Holding Bonds?
Bondholders could benefit from a rate cut because the value of a bond typically increases when rates are cut. This is because most new bonds that are issued after the rate cut will offer a lower interest rate than the current bonds on issue, increasing the value of the older bonds.
On the other hand, bond investors would have a hard time finding new bonds offering a reasonable return if rates are cut.
What Can Investors Do?
As this Rask Media article points out, the worst thing an investor can do in a low-inflation environment is invest in businesses that rely on inflation for growth. I would also be avoiding banks right now because of the risks they face with margins.
Personally, I would rather invest in one of the companies revealed in the free report below.
Disclosure: At the time of writing, Max does not own shares in any of the companies mentioned.