Will interest rates fall to just 1.5% by August?

The Reserve Bank of Australia cut interest rates for the first time in 12 months on Tuesday, but expectations are already mounting that it could look to cut rates again before the year is over.

Tuesday’s official rate cut took most investors by surprise, highlighted by the fact that the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) and high-yield dividend shares such as Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS) soared after the announcement was made.

The cash rate is now sitting at a record low of 1.75%, down from 2% previously, after the RBA said that low inflation numbers could no longer be ignored:

Inflation has been quite low for some time and recent data was unexpectedly low. While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.”

While some economists say the RBA will stop at one cut, others are convinced there will be at least one more which would likely take the cash rate to just 1.5%.

This is partially due to the fact that, historically, the RBA has been reluctant to conduct standalone cuts, preferring instead to conduct policy in cycles, as noted by The Australian Financial Review. Meanwhile, last week’s low inflation figures could result in a downgraded forecast which could prompt the RBA into further action as well.

The AFR also noted a survey by Bloomberg showing that eight out of 24 people interviewed thought the cash rate would fall to 1.5% by the end of the year. The popular consensus appears to be that any cut will occur in August when further data on inflation becomes available.

What this means for investors

One of the most obvious things to consider with lower interest rates is the lower returns you will receive on any cash stored in the bank. By contrast, high-yield dividend shares have the potential to reap far greater annual returns with the added potential for capital gains.

Another thing to consider is the movements of the Australian dollar. The AUD fell sharply immediately after the announcement was made on Tuesday, and has since fallen below US75 cents (from around US78 cents). If the RBA does cut interest rates again, the market could certainly push the AUD even lower which would be very beneficial for local investors holding shares in businesses which generate much of their earnings overseas.

For me, that includes companies such as Westfield Corp Ltd (ASX: WFD) and Cochlear Limited (ASX: COH).

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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 policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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