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Here’s why the RBA will slash interest rates next week

Australian dividend investors will be licking their lips at the prospect of further interest rate cuts, which look likely to occur when the Reserve Bank of Australia meets next week.

The RBA set the tone for further easing in monetary policy when it slashed rates by 25 basis points in February in an effort to force the Australian dollar lower. Although it elected to leave them unchanged at 2.25 per cent in March, the market is pricing in a slim chance that it will continue doing so in April.

To begin with, the Australian dollar is still sitting above the RBA’s target rate of US75 cents, and could rebound higher should the US Federal Reserve elect to increase interest rates at a slower rate than expected. A lower Australian dollar is seen as a necessity to help rebalance the Australian economy which is struggling to gain traction. For instance, unemployment is still sitting near a 12-year high at 6.3 per cent while business and consumer confidence has been shattered.

However, the big reason the RBA will likely look to reduce interest rates when it meets on Tuesday is due to the plummeting iron ore price. Data from the Metal Bulletin shows that the commodity suffered its worst quarterly performance since at least 2009, having plummeted 28% to its current price of US$51.35 a tonne. This could not only impact our miners’ profits, but also employment and the revenue collected by our governments.

Of course, the RBA could refer to Australia’s inflated property prices as a reason not to increase rates, but considering lending to property buyers eased in February, the Board is likely to prioritise the broader economy.

What that means for you

It’s never ideal when the Reserve Bank needs to reduce interest rates to stimulate the economy – especially when they’re already sitting at a record low. It’s also terrible news for most retirees or net savers who have their wealth stashed away in ‘risk-free’ investments or are holding it all in cash. Lower interest rates will further reduce their returns, ultimately impacting their standard of living.

At the same time however, lower interest rates are great news for dividend investors. As rates fall, investors become increasingly attracted to dividends which force share prices higher – just look at Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) which all hit new record highs last week.

Unfortunately, hundreds of thousands of investors have already targeted those stocks, making them unbelievably expensive investments right now. However, a number of other companies such as Woolworths Limited (ASX: WOW), Coca-Cola Amatil Ltd (ASX: CCL) and QBE Insurance Group Ltd (ASX: QBE) are still trading at reasonable prices, and offer yields of 4.7%, 3.9% and 3.5% respectively. While the dividends of Woolworths and QBE are fully franked, Coca-Cola Amatil’s is franked to 75%.

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Motley Fool contributor Ryan Newman owns shares in Coca-Cola Amatil Ltd. You can follow Ryan on Twitter @ASXvalueinvest

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policyThis article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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