0% Term Deposits?

Article published 23 August 2019

0% Term Deposits?

WHAT would happen to term deposits if the Reserve Bank dropped the cash interest rate to zero or below?

The Reserve Bank has said that all options are on the table to stimulate Australia’s economy, potentially even cutting interest rates to zero or negative levels and implementing unconventional policies such as quantitative easing.

First up, why would anyone put their money in the bank if they had to pay for it? Because that’s what a negative interest rate means. You pay the bank, rather than the bank paying you.

Well, for multi-million-dollar deposits it can make sense. It’s not easy to keep millions under the mattress, and it’s dangerous. Pablo Escobar, the notorious drug baron, who kept his cash under quite a few mattresses, you would imagine, made allowance for losing up to 10 per cent of it through mishap and theft. And Pablo wasn’t an easy-going type of guy.

So, it’s not necessarily unreasonable to pay a safe-keeping fee in the form of a negative interest rate on your savings.

But for small savers paying the bank to keep their money might be a bridge too far.

On the bright side, the Reserve Bank is unlikely to simply drop the cash rate below zero and forget about the effects on savers, many of whom are pensioners. It would not be fair, but more importantly, it would not be smart economically. And it’s the economics that really count in the Reserve Bank’s thinking, not fairness.

An interest rate increase is good for savers and bad for borrowers. An interest rate cut has the reverse effect: bad for savers, good for borrowers.

Usually it is enough for the Reserve Bank to cut the interest rate when the economy is a bit slow to encourage business to borrow and invest and stimulate the economy. Conversely, when the economy is getting ahead of itself, it’s enough to raise interest rates to discourage business to borrow and invest.

But when interest rates are negative, cutting interest rates doesn’t stimulate the economy anymore.

The only solution then is cash injections, which in economic jargon is called quantitative easing.

This is something the European Union understood. The European Central Bank introduced two interest rates. One for borrowers (business loans) and one for lenders (small depositors).

The rate is lowered for business loans but raised for small depositors.

Obviously, the bank that loans money at a lower rate than it pays its depositors will make a loss.

But this is where the European Central Bank steps in, covering the loss through quantitative easing.

The Reserve Bank of Australia isn’t yet at the point where the European Central Bank is, but if rates go the same way in Australia as they have in Europe, the Reserve Bank of Australia will do as the Europeans.

For term deposit holders in Australia it means that rates may go even lower, but they won’t go below zero.

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