Should you sell your bank shares after the RBA rate cut?

On Tuesday, the Reserve Bank of Australia (RBA) cut Australia’s cash rate to an all-time record low of 1.5%. According to its statement of monetary policy, the RBA’s hand was forced by “very subdued growth in labour costs” and low inflation. The cut to the cash rate is intended to stimulate the economy via a lower Australian dollar and provide support to domestic demand.

Only time will tell whether Tuesday’s rate cut is effective to spur demand and reignite inflationary pressures on the economy. In the meantime, however, the clear losers from the rate cut appear to be bank shares. Here’s why.

The losers

The immediate losers from a rate cut are the big banks. Although increased economic activity from a rate cut should lead to increased lending demand, any uptick will take time to filter through to bottom line results, meaning bank shares may face short-term pressure on fears of margin contraction.

Margin contraction

Whenever a rate cut occurs, Australia’s big four banks are pressured to pass on a rate cut in full to borrowers. On Tuesday, each of Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) failed to do so with the four majors passing on between 0.10 and 0.14 basis points of the 25 basis point cut.

At the same time, ANZ, CBA and Westpac announced an increase to term deposit rates in a bid to attract more customer funding sources. The trio defended the partial rate cut by lifting short-term deposit rates by up to 60 basis points as the war for customer deposits hots up.

Importantly for investors, the act of reducing the interest rate and increasing deposit rates squeezes the banks’ net interest margin (NIM) – a lead indicator of profitability. This augurs poorly for earnings and is a reason why bank share may come under pressure in the coming weeks.

The winners

However, where there are losers there are also winners; key benefactors from the rate cut, and industries which investors should look to buy, include retail, tourism and housing.

This is because a lower interest rate should increase disposable income (as mortgage rates decrease) and domestic spending (as tourism and employment increases).

Companies which could benefit from this trend are Ardent Leisure Group (ASX: AAD), CSR Limited (ASX: CSR) and JB Hi Fi Limited (ASX: JBH) (to name a few).

Foolish takeaway

Admittedly, the NIMs of banks will be hit by the rate cut, especially in light of increased competition for customer deposits. Whilst this will reduce short-term profitability, Australia’s major banks are strong enough to withstand the current low interest rate environment and therefore are not sells, in my opinion.

Although decreased profitability could lead to lower dividend growth, the respective yields of Australia’s big four trump any term deposit, thus the banks may remain a hold in my books.

For stocks to buy today, investors should focus on companies in industries which will benefit from the rate cut, as well as Our Top Dividend Stock for 2016.

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Motley Fool contributor Rachit Dudhwala owns shares of National Australia Bank Limited and Westpac Banking. 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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