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Michael Grochowski on Falling Interest rates encourage investment in property

The uncertain investment environment and poor returns from shares since the GFC has seen the popularity of bank deposits surge while that of shares has collapsed.  In a recent article published in SmartCompany.com.au on, Shane Oliver explains that the apparent appeal of bank term deposits over investing is shares is not necessarily the best option for investors seeking stability and long term returns.

When asked by the Westpac/Melbourne Institute consumer sentiment survey what is the wisest place for savings, bank deposits are the most popular response, being nominated by over 32% of those surveyed in June, whereas only 5% nominate shares.  Consistent with this, investment dollars have been coming out of funds exposed to shares and piling into term deposits.

However, there are two problems with this. The first is that where the crowd is going is usually not the best place to be for the medium term. For example, in 1999-2000 shares were seen as the wisest place for savings on the back of the tech boom only to then see global share markets collapse with the tech wreck. Second, the rates of interest on bank deposits are getting lower and lower, suggesting it might be wise to look around for more attractive sources of income.

Through 2010 and going into 2011, there were very attractive rates of interest being offered on bank term deposits. At one stage, average bank three-year term deposit rates were around 7%. This reflected a combination of rising official interest rates and competition amongst the banks as they sought to boost their reliance on deposits as opposed to wholesale sources of funding which proved unreliable though the GFC. This competition saw deposit rates rise well above the official cash rate, whereas the norm pre-GFC was for them to run below the cash rate.

The trouble now is that the cash rate is falling, as the RBA has cut rates to deal with softer than expected economic conditions and lower inflation and the battle for deposits has faded a bit. So term deposit rates have fallen sharply. Further falls are likely as the RBA is likely to cut official interest rates to 2.75% to 3% over the next six months on the back of sub-par confidence, disappointing growth and benign inflation.

At present, the standard variable mortgage rate at around 6.82% is only just below its longer term average of 7.25%, but at the past two cycle lows it had to fall to around 6% to ensure a decent recovery in economic activity. What’s more, the neutral level for rates has likely fallen since the GFC, reflecting business and consumer caution.

To ensure that the mortgage rate falls to around 6% and other borrowing rates fall by a similar amount, the official cash rate will need to fall to around 3% or just below, which is what we can expect to see over the next six months.

This downward pressure on mortgage rates is good news for investors looking for better than average returns, as this makes investing in residential property an increasingly sound and stable long term investment.

Michael Grochowski

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