24 February 2017

Why are interest rates so low?

The low-down on term deposits: why savers should forget about higher rates

Do you remember this?

August, 2007: NZ Banks announce a 0.05% lift in one-year term deposit rates to 8.60%.

Those were the days.

And it’s not surprising that many retirees look back with wistful nostalgia on a period when earning 8% on their savings was the norm.

Almost 10 years later, NZ savers have to make-do with 12-month rates well under half that offered by Rabobank and others in the heady era just prior to the Global Financial Crisis (GFC).

According to the latest figures from financial news website, average one-year term deposit rates in NZ sit at about 3.35%. Even over longer periods – where higher returns are traditionally on offer – NZ bank term deposits provide only marginal relief for savers with the best five-year rate currently hovering at just over 4%.

Recently, both NZ mortgage rates and term deposit rates have edged up slightly, sparking some hope for savers that ‘normality’ could be resuming shortly. 

But those hopes are unlikely to be fulfilled any time soon. For several reasons, both global and NZ interest rates look set to be stuck stubbornly low for the foreseeable future.

Despite rising inflationary pressures offshore – primarily in the US market where the Federal Reserve is projected to lift its baseline lending rate from the current 0.75% (up from a bottom of 0.25% about a year ago) – the climb in interest rates is not expected to be rapid.

The Reserve Bank of NZ (RBNZ) is also not in a particular hurry to raise its official cash rate (OCR) from its historic low of 1.75%. Outgoing RBNZ governor, Graeme Wheeler, hosed down any talk of upcoming rate hikes in the central bank’s first monetary policy statement of 2017.

At the February meeting, Wheeler said the OCR, which strongly influences NZ bank term deposit rates, would remain dialled-down for several years.

"Over time, perhaps two or three years, we might start to see OCR increases," he said at the time.

The RBNZ, of course, is not an outlier: most other central banks, especially in the developed world, are committed to holding rates ‘lower for longer’.

Indeed, central banks have copped a lot of flak from some critics for inducing artificially low interest rates beyond their remit. While it’s true that central bank action since the GFC has pushed rates to historic low points in efforts to kickstart spluttering economies into life, the declining interest rate trend actually predates the crisis.

For example, a September 2016 article in The Economist cites research which shows real interest rates in the world’s major economies have been on the slide since the 1980s.

“This era of falling real interest rates might usefully be split into two distinct periods: before and after the financial crisis of 2008-09. In the first period, real interest rates fell from above 4% to around 2%. Since the start of 2008, real long-term interest rates have fallen further, and faster, to around -0.5%,” The Economist says.

Mortgage rates in NZ have fallen steadily over the last 30 years

Mortgage rates in NZ have fallen steadily over the last 30 years

Excluding the GFC-inspired factors, the longer-term fall in global interest rates has been explained by some experts as a so-called ‘savings glut’. This 'glut' is an oversupply of savings fuelled by ageing populations in the developed world preparing for retirement and the entrance of cashed-up Chinese savers into the global market.

“The fall in interest rates since the 1980s reflects a shift in this balance: the supply of savings has increased as demand for it has crashed,” The Economist article says.

But whatever the theoretical arguments, NZ savers will have to face the fact that the days of 8% plus returns on term deposits will have to remain just happy memories.  

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