Rise in US rates little threat

Judging by gyrations in the world's financial markets, ordinary investors are worried the United States Federal Reserve will proceed with its slated intention to increase US cash rates by up to 0.75 per cent a year.

Presumably, market participants consider this action will kill the recovery of the US economy. Even if US cash rates were to increase by this full amount, US investors would still be receiving less than 1 per cent interest on cash and short-term bank deposits.

The reality is that for several years conservative investors have been propping up governments and a banking system brought to its knees by the global financial crisis. Restoring the US and other countries to properly functioning economies requires providing investors, particularly people funding their own retirements, with risk-free returns in excess of inflation.

The Federal Reserve postponed the first 0.25 per cent increase in rates last week. Even though US share markets have fallen from record highs, the economy is performing well and unemployment is at target levels. The Fed has indicated that inflation, already reduced by falling oil and commodity prices, is not a problem demanding immediate action. This suggests that its priority remains to support financial institutions and the share market, rather than to encourage and reward savers.

Australian investors are more fortunate than their US counterparts in having access to higher interest rates and dividend returns on shares because of the imputation credit system. However, with the recent 10 per cent fall in share prices and the growth in company earnings easing, investment returns are likely to be much lower unless interest rates rise.

It's difficult to see how even a 1 per cent rise in US interest rates, which won't occur for some time yet, would be sufficient to trigger an increase in our interest rates. Indeed, given the slowing of the economy because of the fall incommodity prices and reduced growth in property investment, higher US interest rates would help by reducing the need for further interest rate reductions here.

Also, higher US rates would lead to a weaker Australian dollar and thereby aid the restructuring of the Australian economy. A modest increase in US rates is not a threat to Australian savers and investors even if it leads to further gyrations in the share markets.

The Australian economy is fundamentally sound and the Australian Prudential Regulation Authority's recent initiatives have strengthened the financial system. The most serious threat is an extended property boom fuelled by historically low interest rates.

The sooner the US and other major economies start reducing the large subsidies to borrowers and rewarding savers, the more certain our economic performance will be.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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