Primary interest rate outlook for 2025

With global economic uncertainty, it’s always important to understand how the interest rate environment will affect treasury management. While it’s impossible to predict whether the Reserve Bank of Australia will change the cash rate this year, understanding their decision making framework will provide a higher fidelity picture of capital markets. This is important not only for existing treasury management but a broader understanding of the availability of capital for future fundraising rounds. 

Currently, the cash rate has been held at 4.35% in Australia whereas the Federal Reserve cut their equivalent rate by 50bps to 4.75% – 5%. While US monetary policy can have an effect on Australian monetary policy, inflation has been more persistent in Australia than the US. As such, the RBA hasn’t followed suit. They have maintained their hawkish stance of holding rates, indicating they are hardline about getting inflation to their targeted band of 2-3%. As of 31 August 2024, trimmed mean inflation was 3.9% in Australia, coming down from a peak of nearly 7% in December 2022. While there are positive signs of downward movements on inflation, it is still outside the RBA’s targeted band, thus any rate cuts are unlikely, unless there are meaningful drops in trimmed mean inflation over the coming months. The OECD projection is for a 50 basis point cut later in the year by Q4 2024, with most of the big banks projecting no change till Q4 2024 or Q1 of 2025. NAB expects the first cut to occur in May 2025 while CommBank expects it by December this year. The governor of the RBA has suggested that forecasters ‘are getting a little ahead of themselves’ and she anticipates a slower journey to wrangle inflation within the target band. For founders, this means you can expect higher yields on your deposits through to the end of the year. However, you should monitor consumer price index data, as a sudden drop in this quarter’s data could cause the RBA to lower rates earlier than expected. 

The interest rate environment doesn’t just affect your yields on deposits but also your ability to raise capital. There is a direct correlation between interest rates and the level of venture capital activity. When interest rates are low, investors seek higher returns than what is available in fixed income assets, so they invest in more ‘risky’ asset classes such as venture capital. This leads to an influx of capital which will ultimately be deployed into startups. So monetary policy can have a big effect on the ease of fundraising for founders. The last 10 years of low interest rates have been anomalous in the broader picture of capital markets, and coincide with the explosion in venture capital in that same time period. Startups could benefit from the low cost of capital. However, the historical cost of capital has always been far higher. In Australia in the 1990s, the cash rate peaked at 17.5% before it stabilised at a steady 4-7% for the early 2000s. 

We believe that we are reverting to mean, and returning to an environment with higher interest rates for the next financial cycle. However, this may have a lagging effect on the venture ecosystem. This is because venture capital firms raise funds and then deploy them over a 2-5 year time period, often with 7-10 years for the fund to reach maturity. As such, many funds will only raise capital from external investors, after the success of their previous fund. So there is a time lag of when these venture funds go to market to raise capital. However, in this environment, it is likely there will be less demand from investors for this asset class, leading to limited growth of the venture capital industry as a whole. That being said, there is a consensus that the RBA will ease interest rates from its recent high of 4.35% in the next year. This should help bolster the domestic Australian venture capital ecosystem where more venture firms are currently undergoing their own fund raises. Square Peg is targeting a $840 million fund raise. The more rate cuts, the more dry powder the venture capital firms will have to invest in Australian startups. Obviously, interest rates are not the only factor in the amount of VC money available but they are an important factor. General sentiment in the economy can also be a big driver, and we have seen a rebound in investor confidence as venture activity increases. The last quarter recorded the highest level of funding for startups since Q4 2022, with the return of $100M+ deals pushing total funding above $1.5B. 

Given the high interest environment we find ourselves in, treasury management has never been more important. The cost of capital has risen, and while this may make fundraising more difficult, it has its benefits too. Now you can get meaningful yields on your deposits that can have a genuine impact on your bottom line. If you want to learn more about how to take advantage of your deposits or manage your treasury more effectively, please reach out!