What would happen if interest rates started rising?

What would happen to ASX shares if the RBA started raising interest rates again?

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

sdf

What if interest rates started rising again?

It seems unthinkable at a time when rates are at the lowest they've ever been. The Reserve Bank of Australia (RBA)'s official cash rate is currently sitting at 0.75% and many are predicting we could see at least one more cut by this time next year, as you can see in the graph below:

Source: ASX

But at a level of 0.5% or even 0.25%, there's only one direction rates can really go from here – and that's up. Therefore it's not a question of if, but when.

What would cause a rate rise?

Although there are many factors that the RBA analyses when considering a move in interest rates, the main catalyst would be inflation. The RBA (like most central banks) has controlling inflation at the top of its mandate, with a target band of 2–3% set in Australia. As it happens, Australia's inflation hasn't reached that band for years, and has in fact been dangerously close to zero for a few years now – which partly explains why rates are currently so low.

But if inflation was to pick up across the global or Australian economies, the RBA would probably have little choice but to raise rates again. Therefore, the inflation rate is something I keep a close eye on personally.

What would higher rates mean for investors?

In short, it wouldn't be pretty. A higher cash rate translates into higher government bond yields. A government bond is known as a 'risk-free' investment (as an advanced-economy government can never really default on its debt due to its ability to endlessly print money).

This 'risk-free' rate is used to measure all other assets against, so if this rate rises, the intrinsic value of other risky assets like houses and shares will fall in the eyes of most investors. One of the reasons our share market is at record high levels is because of the extremely low risk-free rate we are currently enjoying. But if this was to reverse, its likely we would see a substantial correction on the ASX.

Foolish takeaway

Whilst I don't expect interest rates to rise anytime soon, they very well could. Therefore, I think it always pays to have a think about what could happen in the economy and how that could affect your portfolio. It is for this reason investors should (in my view) think of stocks as quality companies to own, rather than a means to a yield.

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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.

More on Share Market News

a man looks down at his phone with a look of happy surprise on his face as though he is thrilled with good news.
Broker Notes

3 of the best ASX stocks to buy now with $2,500

These shares are highly rated by the team at Bell Potter.

Read more »

Man smiling on top of rocks with mountains in the background.
Share Gainers

Here are the top 10 ASX 200 shares today

Investors were in a nervous mood today.

Read more »

A man in suit and tie is smug about his suitcase bursting with cash.
Broker Notes

2 big-name ASX 200 shares brokers rate as top buys

Let's see which shares could be in the buy zone right now.

Read more »

Broker written in white with a man drawing a yellow underline.
Broker Notes

Top brokers name 3 ASX shares to buy today

Here's what brokers are recommending as buys this week.

Read more »

Frustrated stock trader screaming while looking at mobile phone, symbolising a falling share price.
Share Fallers

Why Block, Catalyst Metals, Coronado Global, and Pilbara Minerals shares are falling today

These shares are having a tough time on hump day. But why?

Read more »

Three happy office workers cheer as they read about good financial news on a laptop.
Share Gainers

Why Beach Energy, Boss Energy, Cochlear, and Light & Wonder shares are pushing higher

These shares are having a good time on hump day. But why?

Read more »

Contented looking man leans back in his chair at his desk and smiles.
Mergers & Acquisitions

Guess which ASX 300 stock is jumping 7% on merger news

This struggling company could be close to merging with a rival.

Read more »

a man in hard hat and high visibility vest talks into a walky-talky device in the foreground of a freight train at a railway yard.
Share Market News

What does the new BHP contract means for Aurizon shares?

This broker sees upside based on a new deal between Aurizon Holdings and BHP. 

Read more »