13 March 2017
Over the past week Australian shares were 1.1% higher. Shares in developed countries lost 0.2% with the US market down 0.4%. Shares in emerging markets lost 0.5%. The Australian dollar was 0.7% lower at 75.42 US cents. The 10 year bond yield in Australia rose 0.17% to 2.98% while in the US, the 10 year bond yield closed 0.10% higher at 2.47%. The oil price lost 9.1% to 48.49 US dollars per barrel.
Term deposits are cash investments held by a financial institution – bank, building society or credit union – for an agreed interest rate over a fixed term. The interest rate earned on term deposits is partly linked to official interest rates, the financial institution’s need for funding and what interest rates competitors are offering. Term deposit rates can differ a lot from cash rates, as shown in the graph below.
We can see in the chart above that there are times when term deposit rates are greater or less than official cash rates. For example, term deposit rates were greater than the official cash rate in 2012 through to 2014 and lower in 2002 through to 2007. There are a number of reasons for this:
- Term deposits have a longer term, in the case above six and 12 months, compared to the official cash rate which has an effective term of one day. In fixed interest markets different rates are offered for different terms, partly based on the expectation of future interest rate changes.
- Term deposit rates are influenced by supply. Term deposits are just one of many sources of funding for financial institutions, including basic deposits and bonds. Interested investors might be based in Australia but are also all around the world. If there are attractive funding opportunities elsewhere then banks might not need to issue many term deposits and hence reduce the interest rates they offer.
- Term deposits are also influenced by demand. For instance if demand for term deposits is high then banks will likely reduce the rates they offer and vice versa.
Term deposits appear simple but the rates on offer are a result of a complex interaction of supply and demand factors. Nonetheless the decision rests with investors – do you want to invest at the rate on offer?
David Bell and Michael Berry