Here’s why an August interest rate cut could be on the cards

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Investors hoping for an interest rate cut earlier this month were left bitterly disappointed when the RBA elected to keep interest rates on hold. However, it seems they could get their wish sooner rather than later.

According to the ASX’s RBA Rate Indicator, market participants are pricing in a 19% chance of an interest rate cut at the central bank’s July meeting. Those odds aren’t sky high and suggest the cash rate is most likely to remain at 1.75% for another month.

However, it seems the odds of an August rate cut are stacked in favour of those investors looking for further stimulus, as the June quarter CPI inflation data will be released on 27 July. This information will likely be one of the deciding factors for whether the RBA should cut interest rates again as it battles against the possibility of deflation, or a reduction in prices of goods and services in the economy.

According to The Australian late last week, a whopping 96% of economists surveyed by Bloomberg expect an interest rate cut when the RBA meets on 2 August, while 35% expect at least two cuts by September 2017. That means we could be looking at a cash rate of 1.25%, or perhaps even lower, within the next 15 months.

By comparison, market participants aren’t quite as optimistic for an August cut, pricing in a 46% chance of a cut, as noted by The Australian.

How should you invest?

Lower interest rates are very unfortunate for most retirees. After all, many retirees elect to keep the bulk of their wealth in cash (as it is usually considered the safest option), so lower interest rates reduce their interest returns. In other words, they will be forced to spend more of their principal each year as opposed to living off their interest payments.

The bad news for them is that interest rates appear almost certain to remain lower for longer, regardless of whether the RBA does provide any more stimulus.

As such, many of these investors are turning to ASX-listed shares offering solid dividend yields. For instance, it’s hard to ignore the 5.7% fully franked dividend yield (grossed to 8.2%) offered by Telstra Corporation Ltd (ASX: TLS) when you’d be lucky to get even a quarter of that in a savings account.

Wesfarmers Ltd (ASX: WES), owner of Coles and Bunnings Warehouse, is another attractive alternative, as is toll road operator Transurban Group (ASX: TCL). The pair generate strong cash flows and offer a fully franked dividend yield of 5% and a partially franked dividend yield of 3.9%, respectively.

In my opinion, interest rates probably will decline from here, although the timing is uncertain and would largely depend on data available to the RBA at the time. For instance, if the June quarter CPI data is particularly weak, then an August cut is certainly possible.

However, rather than focusing on when or even if the RBA will cut rates further, it’s worth noting how unlikely it is that they will raise interest rates anytime soon. Big dividends may be one of the best strategies to follow right now for better investing returns.

What's more, the market is volatile right now, particularly in the lead-up to Britain's vote to potentially leave the European Union. Some of the better shares to hold during times of such uncertainty are those which pay decent dividend yields -- not only because they offer a steady stream of income, but also because those businesses which can afford to pay dividends are typically considered more stable than those which do not.

Discover The Motley Fool's top 5 ASX dividend stock ideas for 2016 to get you started building a more diversified income portfolio that is paying you back! Click here to learn more.

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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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