With the Reserve Bank of Australia (RBA) cutting interest rates last week, it is certainly the primary topic of conversation around the proverbial water cooler this month.
The RBA's 25 basis-point reduction was the second interest rate cut of 2025, and brings the cash rate down to 3.85%.
Most commentary surrounding interest rate changes focuses on the impact on mortgage holders. However, the impact of interest rate changes extends far beyond the interest repayments that property owners face.
Just ask legendary investor Warren Buffett.
Buffett has long talked about how important interest rates are to businesses and investors.
Some investors might know that interest rates do have a direct impact on financial markets, including the stock market. The general presumption is that rate rises hurt shares, while rate cuts are good news.
But it goes far beyond that.
Luckily, Mr Buffett, as usual, has gifted investors with some memorable and characteristically pithy explanations as to how this plays out. A common theme in these explanations is that interest rates act as 'financial gravity' in the world of investing.
Buffett: Interest rates are financial gravity
Here's a quote Buffett made at the annual general meeting for Berkshire Hathaway Inc back in 2013:
You know, interest rates are to asset prices, you know, sort of like gravity is to the apple. And when there are very low interest rates, there's a very small gravitational pull on asset prices…
So, interest rates power everything in the economic universe, and they have some effect on the decisions we make… So, if you wanted to inflate asset prices, you know, bringing down interest rates and keeping them down at first, nobody believed they'd stay down there very long, so it reflects the permanence that people feel will be attached to the lower rates.
He said something similar in an interview in 2016:
[A low interest rate] does have an effect of making all assets more valuable. Interest rates are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on value.
That's all well and good. But those comments were very generalised in nature. Fortunately, Buffett went a bit further in an interview back in 1994:
The value of every business, the value of a farm, the value of an apartment, the value of any economic asset is 100% sensitive to interest rates. The higher interest rates are, the less that present value is going to be. Every business, whether it's Coca-Cola or Gillette or Wells Fargo — its intrinsic valuation is 100% sensitive to interest rates.
This is, at least in my view, the most important concept an investor can take away from Buffett.
The value of every investment is sensitive to interest rates. Think about it. When rates rise, term deposits, government bonds, and savings accounts become more lucrative as the interest one can secure on their cash increases.
At the same time, individuals, companies, and governments have to pay more if they wish to borrow money. That means a property secured with a loan becomes less valuable, as does a business with borrowed money on its books.
Conversely, rate cuts can reduce the value of cash-based investments but boost those that employ borrowed money, which includes most ASX shares.
So if the RBA delivers additional interest rate cuts this year, you'll know why investors (and property owners) will be popping the champagne.
