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How low interest rates benefit all

November 8 2002
By Richard Salmons

If, instead of a direct deposit into your bank account, you had asked your boss to put your money directly into bank shares, you would have grown four times richer over the past decade, market figures reveal.

The vast difference in returns between bank deposits and bank shares reflects the experience of a decade of low interest rates alongside a booming sharemarket.

Assuming that shareholders in the big four banks paid their dividends back into buying more shares, they would have secured a total return of 1044 per cent, or a more than 11-fold increase in their capital. The Australian sharemarket as a whole achieved a much smaller, albeit respectable, return of about 200 per cent - a tripling in value - over the decade.

The decade of low interest rates, though, is reflected in the paltry returns from interest-bearing deposits. Taking the Australian government bond as a proxy, the total return from relying on interest rates was 127 per cent over the decade. (This return is based on an average of Australian government bonds over the decade.)

The big gains for the sharemarket has reflected the three largest ways that a low interest rate environment is generally good for business.

First, the lower the rates, the lower the profit returns companies need to justify for new ventures such as building a new factory. This is a good time for businesses to expand.

Second, low interest rates also mean consumers have more money in their pockets, so companies increase their sales.

Third, companies have lower interest bills so net profits are greater.

Banks also end up being big winners from low interest rates. The high level of economic activity means businesses and consumers take more loans. Low rates also mean fewer defaults on loans. In addition, banks are big investors in stocks and bonds, so they benefit as low rates increase their value.


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