Interest rates could be on the rise sometime in 2017.
That will likely come as a shock to many Australians. The Reserve Bank of Australia has been engaged in a cutting cycle since November 2011 when it decided to lower the cash rate to 4.5% from 4.75%. While the cash rate paused at 2.5% in 2014, the central bank has since cut interest rates another four times to just 1.5%.
You can see this on the chart below, courtesy of the RBA.
Many economists were of the belief the RBA would continue to cut interest rates, perhaps to a low of around 1%. However, it is also believed that the positive impact of interest rate cuts at these levels is dwindling, adding little in the way of consumer confidence.
At the same time, lower interest rates can act to encourage people to take out more debt to buy property, potentially making them more vulnerable to a pullback in economic conditions.
As such, the Organisation for Economic Co-operation and Development, or the OECD, has urged the RBA to consider lifting interest rates in 2017 to avoid a bubble in the housing markets, according to The Australian Financial Review.
While the RBA would be hesitant to do so out of fear of inflating the Australian dollar, the US Federal Reserve is also expected to continue lifting interest rates which would offset some of that risk. The OECD said in its recent economic forecast summary:
"Monetary policy tightening is expected to commence towards the end of 2017 and this is appropriate given likely monetary-policy developments elsewhere, the cyclical development of the domestic economy and the need to unwind tensions from the low-interest environment, notably in the housing market, which has in many places experienced rising prices for some time."
It continued:
"The government envisages fiscal consolidation. In the event of disappointing growth, however, fiscal rather than monetary support should play the leading role given the housing-market concerns and fiscal leeway. Tax reform should be a core element of structural policy."
Without sugar-coating it, rising interest rates can have a negative effect on shares including those which offer high dividend yields. This is because, as interest rates rise, their dividends can become less attractive – particularly if their share prices are already somewhat expensive.
Shares of high-yield dividend businesses such as Sydney Airport Holdings Ltd (ASX: SYD) and Transurban Group (ASX: TCL), for instance, were sold down heavily in response to the election of Donald Trump in the United States. This is because his election sparked greater expectations of a faster increase in interest rates in that country, and potentially in Australia as well.
However, both companies have since rebounded strongly and are now trading higher than they were when Trump was elected.
Shares of the big four banks, namely Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC), have also risen in the time since. NAB shares are trading more than 10% higher since that time.
What this means
Rising interest rates does not mean you should take all of your money out of the share market. What it does mean is that, as always, you should consider what is happening in the broader economy before investing in certain industries or businesses, and ensure you are buying reasonably priced businesses which represent good long-term value.
It's also important to note that this doesn't mean the RBA will start increasing interest rates just yet. It may decide to sit tight on the 1.5% cash rate for a while yet, or else increase interest rates at a very slow pace. Notably, it could also cut interest rates again, although that seems less likely to happen now.
Investors shouldn't get too caught up speculating and continue to focus on the bigger picture. Right now, the cash rate is sitting at a mere 1.5%, and could be there for some time yet.
