As I said in my blog in October last year, interest rates were tipped to fall 0.5% down to 2.75%. This has now happened.

So how low can they go?

The looming slowdown in mining investment growth led the RBA to start cutting the cash rate from 4.75% in November 2011. Higher growth and investment in non-mining sectors is required to pick up the slack. Lower interest rates are intended to encourage business investment in other growth sectors.

If the RBA doesn’t see conditions improving and the growth they are hoping for, it is quite possible they could cut again in the next few months down to 2.5%.

What does this mean for investors?

Great news if you have a home loan as your repayments are set to fall. However, if you hold a lot of cash or term deposits, your rate of return is going to get worse. Term deposits are averaging around 4% per annum and likely to head down towards the low 3% range.

After factoring in the effect of inflation, the real return investors are receiving from holding significant amounts of cash and term deposits is very low.

As a result much of this money has found a new home in the sharemarket over the past year, in particular high yielding stocks. This has helped drive the share market higher. Rising share prices have resulted in dividend yields declining. However, the dividend yield on Australian shares remains healthy at 5.5%, including franking credits. Far more attractive returns when compared to 4% on term deposits.

Falling interest rates should continue to boost the outlook for company returns. It should also put downward pressure on the Australian dollar benefiting companies with offshore earnings.

The key to managing external policy changes, such as RBA cuts, is to have a diversified portfolio with a good mix of income and growth characteristics.

If you would like to discuss this in more detail please feel free to contact us 96821900.