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

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

Person pretends to types on laptop drawn in sand.
Share Gainers

Here are the top 10 ASX 200 shares today

It was a miserly session for investors today.

Read more »

Modern accountant woman in a light business suit in modern green office with documents and laptop.
Opinions

Too high? These 2 ASX shares might be due for a correction

These popular blue chips are looking dicey to me.

Read more »

A man clenches his fists in excitement as gold coins fall from the sky.
Broker Notes

These ASX 200 shares could rise 20% to 35%

These shares are being tipped to deliver market-beating returns by analysts.

Read more »

Keyboard button with the word sell on it.
Broker Notes

8 ASX All Ords stocks downgraded to sell ratings

Find out which shares are out of favour with the experts.

Read more »

Woman smiling whilst shopping in a clothing store.
Dividend Investing

Why this quality ASX 300 dividend stock is tipped to surge 54%

A leading fund manager forecasts significant outperformance from this quality ASX 300 dividend stock.

Read more »

A group of businesspeople clapping.
Broker Notes

Bell Potter names more of the best ASX 200 stocks to buy in June

These stocks could be best buys this month according to the broker.

Read more »

A businessman looking at his digital tablet or strategy planning in hotel conference lobby. He is happy at achieving financial goals.
Share Market News

Why Clarity, Coronado Global, Iperionx, and Lynas shares are roaring higher today

These shares are having a strong session on Thursday. Why are investors buying them?

Read more »

A woman looks questioning as she puts a coin into a piggy bank.
Opinions

The ASX 200 is approaching its all-time high. Here's why I'm not buying shares

I'm not seeing what the broader market is.

Read more »