The Reserve Bank of Australia’s (RBA) decision today to lower the official cash interest rate by 0.25% to a record low of 2.75% has surprised many, as reported by Motley Fool analyst Mike King here.
For many companies the lower rates will be beneficial. These include discretionary retailers such as department stores Myer (ASX: MYR) and David Jones (ASX: DJS), whose customers should now have more disposable income to spend in store. Likewise, all manner of exporters from resource companies such as BHP Billiton (ASX: BHP) to biotech companies like CSL (ASX: CSL) stand to benefit from the flow-on effect of lower rates, a weaker Australian Dollar (AUD). Indeed in the aftermath of the rate decision the AUD was down to $1.018 against the US dollar.
So that’s the good news, now for the bad news
Many financial services businesses’ profit line is buoyed in a higher interest rate environment. One of the most exposed companies to lower interest rates is QBE Insurance (ASX: QBE). Since the GFC when interest rates were slashed, QBE has been earning a pittance on its large cash balance. While some insurers invest a greater portion of their float (premiums) in equities, QBE plays it conservatively, primarily holding cash and investing in fixed interest securities. With domestic rates down and lowly overseas rates of around 1%, both domestic and off-shore QBE funds are earning a poor return.
The outlook for the profits at major banks is diminished too. It is easier for banks to earn excessive margins when interest rates are high, with lower rates putting a squeeze on their net interest margin. Indeed as we saw today, the banks have immediately moved to pass on the full interest rate cut, bowing to political pressure and setting them up for a margin squeeze.
For a company, depending on where it stands, a lower interest rate can be a pro or a con. Either way it should be remembered that the RBA cut rates because it sees a weakening economic outlook that it must try to turn around.
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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur owns shares in QBE Insurance.