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The drop in the official cash rate from 4.25 per cent to 3.75 per cent would normally be expected to benefit stock prices. But according to two reports by Deutsche Bank analyst Tim Baker, the effect will be mixed. The interest rate cut may not have a positive effect on share prices, but it will lead to a greater focus on stocks with high dividend yields.
Baker says the rate cut is unlikely to lead to a rise in the capital value of the shares. He says the easing cycle has so far taken 100 basis points (1 percentage point) off the Reserve Bank’s cash rate, but it has only reduced actual borrowing rates by 80 basis points.
“In other easing cycles, rates were lowered by at least 200 basis points, and it happened more quickly,” he says. “Even taking into account households’ higher sensitivity to rates given high debt, this cycle is on the small side. And we don’t see much more to come. Soft inflation has been driven by the rise in the Australian dollar, while non-tradables inflation has barely budged. And there’s still a multi-year capital expenditure boom for the economy to accommodate.”
JPMorgan economist Stephen Walters agrees further cuts are unlikely. He says officials are likely to “sit back and admire their handiwork”. Further cuts will only come if there are material disappointments offshore or the jobless rate rises more than anticipated. He calculates that a further move is unlikely until the second half of the year.
The prospects for a big jump in the stockmarket may be poor, but the lowering of interest rates does increase focus on high dividend yielding stocks. Baker says the gap between equity and bond yields rose markedly in 2011.
“For investors after income, Australia offers a high dividend yield. The yield has historically been 1.5 to 2 per cent higher than offshore markets, due to Australia’s dividend imputation system, which encourages companies to pay dividends. Further, the payout rate is currently a little below average and could rise.”
The divergence between the official cash rates and bank rates helps fixed interest yields for investors, however. Peter Warnes, head of equity research for Morningstar, argues that the battle for deposits is heating up because of Australian banks’ heavy dependence on wholesale debt markets.
“Since 2008, when capital markets effectively closed down,” he says, “the bank funding outlook has been variable and will probably tighten, suggesting an increase in the cost of funds.”