INSIGHTS

Savers have had a tough time in recent years, and even though interest rates are on the way back up, the prospect of poor returns remains.

Just before the pandemic hit, six-month term deposit rates had fallen to the lowest since the 1960s, at around 2.5 per cent.

Amidst all the emergency stimulus of 2020, they fell even further. For the best part of 12 months, the deposit rate from the major banks was 0.8 per cent. This falls to a pitiful 0.6 per cent, if one assumes a personal tax rate of 30 per cent.

Conservative savers were forced to choose between taking on more risk than they had signed up for, or staying put and getting left behind.

Today, interest rates are rising again, so a period of more attractive returns is ahead. Or is it?

The Reserve Bank has increased the Official Cash Rate (OCR) twice in quick succession, and the six-month deposit rate his improved to 1.4 per cent in response.

Up to six more hikes are expected in 2022, which could take the OCR above two per cent by the end of the year.

That could see the term deposit rate at close to three per cent, more than double where it is today and back to pre-COVID levels.

However, inflation is expected to be higher over this period too, so while the headline rate looks much improved, in “real” terms (which means after adjusting for inflation) returns look even worse than before.

Today’s deposit rate of 1.4 per cent falls to 1.0 per cent after tax, while the annual inflation rate is running at 4.9 per cent. That means savers are, in fact, getting a real return of -3.9 per cent per annum.

That’s the worst return since 1980.

It’s probably not going to get better in a hurry either. The Reserve Bank sees inflation rising to 5.7 per cent over the next six months, before falling to 3.3 per cent by the end of 2022.

If deposit rates track their historical path relative to the OCR (and accounting for the eventual end of the funding for lending programme), savers could be facing negative real returns until the middle of 2023.

That’s also contingent on inflation falling back to below 2.5 per cent, as the Reserve Bank is hoping. Many would argue we could be underestimating how persistent the current cost pressures are, and that inflation might not fall as much as that.

Inflation is a tax on your savings, silently eroding your purchasing power in the background, and making you poorer.

Even at just three per cent, inflation reduces the purchasing power of a dollar by 13.7 per cent over five years, or 25.6 per cent over ten years.

Financial repression is the term economists use for an environment like this, when interest rates are consistently lower than the rate of inflation.

When government debt is very high, as is the case today, there is an incentive to keep rates low to minimise debt servicing costs. If inflation runs a little bit hotter at the same time, that’s also handy as the real value of this debt is reduced.

This all comes at the expense of savers, who are disadvantaged because of the low returns they get.

It’s impossible to predict how inflation will play out over the next few years, or how central banks and interest rates will respond.

However, one thing is clear. If you’re expecting a return to the good old days, when term deposits offered a fair return, don’t hold your breath.

It’s the real interest rate that matters, and savers look set to remain on the losing end of that for some time yet.

This article was also published on the New Zealand Herald website under the title "Mark Lister: How much can your money make in the bank?" on 5 December 2021.