For those looking to invest in term deposits, an increase in interest rates will generally mean higher rates of return. But, for those holding fixed interest investments such as government and corporate bonds, interest rate increases may mean the value of these bonds will decrease.
Term deposits usually offer higher returns in a rising interest rate environment and lower returns in a falling interest rate environment.
This is the reason investors may hold a diversified investment portfolio, less sensitive to immediate interest rate changes.
Interest rates and personal finance
For many Australians, a rise in interest rates will mean increased repayments on mortgages, loans and credit cards. With less disposable income, many people may need to tighten their belts.
Interest rate rises can be tough for families and small businesses, as increased mortgage and debt repayments can make life more difficult and expensive.
Lower interest rates on the other hand can mean a respite in terms of lower debt repayments and provide an opportunity to get ahead on debt such as mortgages.
When reviewing your finances, it pays to make sure you look at how interest rates are tracking and if necessary, build in a buffer for further increases that might affect your repayments. It may also be worth looking at consolidating your debts and renegotiating your current interest rates to protect yourself from future increases.
Interest rates and investments
The value of fixed interest investments such as government and corporate bonds will decrease with interest rate increases. This is because the capital value of a bond falls as interest rates rise.
While lower interest rates can mean an increase in the capital value of these bonds, any new money invested in bonds will occur at lower interest rates and the yield or return you receive will be lower in the future.
Also, as Australian interest rates rise, the Australian dollar generally strengthens against other currencies, as overseas investors are attracted to a higher yield, driving up demand for the Australian currency. In the same way, this can reduce the returns from global shares for Australian investors.
When interest rates fall, the Australian dollar can weaken, making Australian commodities and exports more affordable for offshore buyers.
It’s worthwhile to regularly review how the latest interest rates affect your investments to make sure you stay on track with your investment strategy.