Will an RBA interest rate cut save the ASX? // Motley Fool Australia

Will an RBA interest rate cut save the ASX? // Motley Fool Australia

Today, the Reserve Bank of Australia (RBA) is considering whether to change the official cash rate from its current level of 0.75%. Theoretically, there are three possible outcomes – a raise in rates, a cut in rates or the status quo. In practise, rates are either going to stay where they are or be cut.

We’ll know the outcome later today.

Today, the Reserve Bank of Australia (RBA) is considering whether to change the official cash rate from its current level of 0.75%. Theoretically, there are three possible outcomes – a raise in rates, a cut in rates or the status quo. In practise, rates are either going to stay where they are or be cut.

We’ll know the outcome later today.

Why would the RBA cut interest rates?

A cut in interest rates is supposed to support the economy by lowering the costs of borrowing money and the interest on all existing loans (like mortgages). The idea is that if consumers are paying less on their mortgages and loans, there’s more money to spend on other things – leading to a boost in economic growth.

And our economy is probably in need of some assistance due to the impacts of the coronavirus – which come on top of a summer of unprecedented destruction from bushfires.

That’s why many pundits are expecting a cut today.

What will that mean for investors and ASX shares?

Well, the first thing you might notice is that your bank account will be paying you a whole lot less than it is now if rates do get cut. There’s no such thing as a free lunch, so if mortgages get cheaper, the cost of saving becomes higher. Thus, term deposits, savings accounts and government bonds will all become even less enticing than they already are if rates are cut today.

But all eyes will be on ASX shares here at the Fool. Warren Buffett likes to say that interest rates act as the gravity on all investments – property, shares… you name it.

If rates are high, the attractiveness of a 7% term deposit over shares (and the volatility they bring) will pull capital out of the share market. But the inverse is also true. And that’s why a rate cut will be good for ASX shares and the share market.

After all, if you want a 5% yield on your cash, you won’t find too many other places to get it apart from franked dividend shares like Commonwealth Bank of Australia (ASX: CBA) or Telstra Corporation Ltd (ASX: TLS) these days.

Foolish takeaway

As to whether a rate cut today will save the ASX (or more accurately, stem last week’s losses) is uncertain. If the RBA does cut, it will again deplete its stock of dry powder to a very low level for any future shocks. What investors will make of this… well, we might just find out tomorrow.

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Motley Fool contributor Sebastian Bowen owns shares of Telstra Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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