Why are term deposit rates so low?
Term deposit rates are mainly determined by money markets rates, which in turn are heavily influenced by the RBA’s cash rate. Individual banks and other financial institutions have some flexibility to set their deposit rates, but they will rarely deviate much from the prevailing market interest rates.
The chart below shows the history of the RBA cash rate and the average six-month term deposit rate of Australian banks. While there have been periods where deposit rates diverge from the RBA cash rate this has become less common in a low interest rate environment.
The difference between bank term deposit rates and the wholesale market interest rate is influenced by a range of factors that impact the supply and demand for bank funding. Term deposits are an important source of funding for banks. They receive favourable regulatory treatment compared to other funding sources. Each individual bank will have differing funding needs which will impact the rate that they will offer in the retail markets for deposits.
Individual bank decisions about the rate they will offer on term deposits are secondary to the influence of the prevailing market interest rates in determining the level of term deposit rates.
In answering the question of why deposit rates are so low, the question really becomes why the RBA’s cash rate is so low? The RBA has gone to great lengths to explain this in recent years. The economic shock from the pandemic triggered a reduction in the cash rate to near zero, the current 0.10% rate. Even prior to the pandemic interest rates were low.
For many years prior to the pandemic, the RBA had resisted the global trend for zero rates. The magnitude of the economic shock from the pandemic, combined with uncertainty about where the economy was headed, changed all that and now the RBA cash rate, at 0.10%, is in line with global interest rates.
The RBA sets its interest rate at a level that it believes will get inflation to its 2% to 3% target while keeping the unemployment rate as low as possible. Inflation has been unusually low over the past 5 years, averaging an annual rate below the RBA’s target.
In the past year, the RBA has made it quite clear that it will not be raising rates until inflation is at the top of its target band. This is unlikely to occur before late 2023, in its view.
The implication of the RBA’s policy stance is that the RBA cash rate and bank term deposit rates are not expected to move much from current rates for a number of years.
For people seeking the best returns on their term deposits, this means that every basis point counts. A basis point is 1/100th of a percent. With the RBA cash rate set at 0.10% (10 basis points) and term deposit rate in the market anywhere from 0.50% (50 basis points) to 2% (200 basis points), the benefit to getting a rate that is 10 or 20bp higher than another product is meaningful to total returns.
How do term deposit rates compare to other investments?
Government guaranteed term deposits from banks are low risk investments. Like government bonds, these investments are guaranteed by the Australian government to return the original capital value (up to a limit of $250,000 per customer).
These virtually “risk-free” rates anchor the returns from other investments. The next level of risk for investors is what is known as capital stable investments. Like term deposits and government bonds, investors are effectively providing loans to another party in return for an interest payment. Capital stable investments are things like term deposits in non-government guaranteed financial institutions and the purchase of bonds from companies. Even though the interest payments (coupons) are fixed, the probability of losing the original invested amount is very low.
Beyond risk free and capital stable are risky investments in equity and property markets. These investments usually have an ownership dimension, and the value of the investment can change as the capital value of that ownership changes. There is also regular payment in the form of dividends and rents. These risky investments can produce high returns, but they can also result in large losses of the underlying capital value.
In the year to September 2021, the value of Australian residential housing increased, on average, by about 20%. This is one of the largest increases in house prices in Australian history, and when rents are added in (net of costs), the returns to property investment are more than 10 times the return from term deposits. However, property prices can go down as well. There have been a number of years when the value of property has declined by between 5% and 10% in a year. According to the Australian Bureau of Statistics, established house prices fell by amost 8% in fiscal 2019. House prices fell by almost 5% in 2011 and in 2008. It must also be considered that there are much higher costs associated with property investment. Search costs, funding costs and tenancy risk all come into play. A term deposit is a low-cost simple investment with a high degree of certainty of return.
Even in equity markets, where the costs of investment through managed funds or direct purchases of shares can be low, there is still capital risk. Equity markets, like property markets, have experienced a large rise in value in the past year. Australian shares delivered a total return of 30% in 2020/21. This is the highest annual return in decades. Over the long run the average return is 10%. However, in approximately 1 in 5 years, the equity market experiences a decline. The current low level of interest rates suggests low growth and lower returns from equity and property markets in the future.
Although low yielding risk free returns in deposits and bonds appear unattractive compared to the returns seen recently in property and equity markets, investors should not forget about the risks that come with these investments. Many factors will determine each person’s investment risk appetite, and everyone should seek independent financial advice. For example, the longer your investment time frame, the more risk one should be willing to take. A 20 or 30 year horizon for your investment should allow it to ride through the ups and downs of the market to even out returns.
If your investment horizon is much shorter, risk appetite should be less. If you are saving for a house deposit and plan to need it within 3 years, a risky investment may see a big decline in the investment value just as you need the money.
There is an important role for term deposits in the capital market. As either a core low risk component of a long-term investment portfolio, or as a vehicle for meeting a short-term saving objective, term deposits are transparent, safe and reliable investments, even if the returns are a little lower than in other investment markets.
For more information about Judo’s Term Deposits and to view our competitive interest rates, visit Personal term deposits or contact us on 13JUDO.
This document has been prepared by Judo Bank Pty Ltd ABN 11 615 995 581 AFSL 501091 (“Judo Bank”). Any advice contained in this document has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this document, Judo Bank recommends that you consider whether the advice is appropriate for your circumstances.
So far as laws and regulatory requirements permit, Judo Bank, its related companies, associated entities and any officer, employee, agent, adviser or contractor thereof (the “Judo Bank Group”) does not warrant or represent that the information, recommendations, opinions or conclusions contained in this document (“Information”) is accurate, reliable, complete or current. The Information is indicative and prepared for information purposes only and does not purport to contain all matters relevant to any particular investment or financial instrument. The Information is not intended to be relied upon and in all cases anyone proposing to use the Information should independently verify and check its accuracy, completeness, reliability and suitability and obtain appropriate professional advice. The Information is not intended to create any legal or fiduciary relationship and nothing contained in this document will be considered an invitation to engage in business, a recommendation, guidance, invitation, inducement, proposal, advice or solicitation to provide investment, financial or banking services or an invitation to engage in business or invest, buy, sell or deal in any securities or other financial instruments.
The Information is subject to change without notice, but the Judo Bank Group shall not be under any duty to update or correct it. All statements as to future matters are not guaranteed to be accurate and any statements as to past performance do not represent future performance.
Subject to any terms implied by law and which cannot be excluded, the Judo Bank Group shall not be liable for any errors, omissions, defects or misrepresentations in the Information (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the Information. If any law prohibits the exclusion of such liability, the Judo Bank Group limits its liability to the re-supply of the Information, provided that such limitation is permitted by law and is fair and reasonable.
This document is intended only for clients of the Judo Bank Group, and brokers who refer customers to the Judo Bank Group, and may not be reproduced or distributed without the consent of Judo Bank.
The Information is governed by, and is to be construed in accordance with, the laws in force in the State of Victoria, Australia.