Posted by on
01/12/2023
Away from Flemington racetrack Australian borrowers let out a collective groan on Melbourne Cup Day when the RBA delivered the first increase to the cash rate since June. That makes for the 12th interest rate increase since May of 2022 and lifted the cash rate to 4.35%, the highest since November 2011. While unwelcome news for beleaguered borrowers, the silver lining might be that a lift in the cash rate can also lift rates of interest payable on some bank deposit products.
Higher interest rates on deposit products means that the old adage of “cash is trash” is no longer true. Deposit rates are starting to look very compelling as the falling inflation rate may make it possible for savers to earn real returns on their savings for the first time in years. The RBA is currently forecasting the annual inflation rate to fall to 4.5% by the end of the year, and 3.9% by the middle of next year. At the same time, it’s possible to lock in 12 month term deposits with rates above 5%, and variable rate online savings accounts can offer even juicier returns if you don’t mind running the risk that interest rates may fall again before you need to withdraw the money.
Basically, the rates payable on ‘at-call’ deposit products tend to bear a close relationship to the cash rate, because the cash rate determines the cost of “overnight” money, which is the shortest lending period in the money markets. Term deposits are a little bit different because they allow you to lock in a rate for the ‘term’ that you choose. This means that term deposit rates bear a closer relationship to rates in the interbank swap rate market, which is driven by a variety of factors including the best guess of traders about where the cash rate might be in the future.
With the RBA now forecasting inflation to fall back towards their 2-3% target band, and the pain inflicted on borrowers causing the economy to slow down, some analysts are starting to question whether we have hit the peak in interest rates, and when we might turn our minds to the timing of rate cuts. Central bankers have been coy about providing too much guidance on the path ahead and who could blame them after former RBA Governor Philip Lowe’s infamous prediction of “no rate rise until 2024 at the earliest” proved to be wildly wrong.
New Governor Michele Bullock has been talking up the potential for further rate hikes recently, but we’re not convinced. We think that the economy will slow quickly enough from here that the RBA will not need to raise the cash rate any further to bring inflation to heel. We are seeing strong progress on inflation in the United States and Europe, and China is now experiencing deflation, so the offshore headwinds of 2021-22 have suddenly turned into a tailwind for the RBA.
In terms of interest rate cuts, the RBA will want to be sure that the inflation dragon has definitely been slain before they take their foot off the pedal. That might mean that we have to wait a little bit longer for any cuts to arrive, but that allows savers to enjoy healthy returns in the interim. Financial markets are currently priced for one rate cut by the end of 2024, but that might be brought forward if the economy deteriorates faster than expected. If that happens, we could see those generous term deposit rates start to fall first, as expectations of the average cash rate in the future shift downwards.
Depending on how the economy plays out over the next few months, and how successful the RBA is at taming inflation, we could be very close to the cyclical peak in interest rates for some deposit products.
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