What are interest rates doing to your term deposit?

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Record low interest rates not good news for term deposit holders 

European elections

Winner of the 10 day holiday in a KEA motorhome announced

By Murray Harris, National Investment Manager, Spicers

The latest announcement from the Reserve Bank Governor, Dr Allan Bollard, on the 26th April regarding the outlook for interest rates in New Zealand will not have been welcome news for those relying on bank term deposits to generate income in retirement. Dr Bollard commented that despite the NZ economy showing signs of recovery; housing market activity continuing to increase; and signs of a recovery in building activity, that inflation appears to be under control and is expected to remain in the middle of the Reserve Bank’s target range of 1 to 3%.

Dr Bollard also noted however, that the global economic outlook remains a concern and financial market sentiment remains fragile. So the back drop from which Dr Bollard must decide the next move for NZ’s Official Cash Rate (OCR) is mixed. Domestically, things are ticking along ok. Globally, the environment is more challenging.

Any slowdown in demand across the global economy will undoubtedly have implications for the products and services which NZ companies sell to the rest of the world. Demand for our goods – meat, wool, wood, dairy products etc. by the rest of the world has been very strong as the global economy has recovered from the depths of the GFC recession. That has been a double-edged sword though, because that demand for our goods and services (which are paid for in NZ dollars), has pushed the value of the NZ dollar to record highs against other world currencies.

And that was another point raised by Dr Bollard, and a reason why the OCR remains firmly fixed at 2.5%. In fact he noted that, the NZ dollar has remained elevated despite recent falls in commodity prices. And that if the NZ dollar remained strong, the Reserve Bank may need to reassess the outlook for monetary policy. That means interest rates could actually be cut further!

What this means is the high level of the NZ dollar is doing the “tightening” for the Reserve Bank. That is to say, as an export based economy, the high NZ dollar is making it harder for our exporters to be competitive, and therefore is constraining their ability to generate growth which flows through to stronger domestic economic growth and inflation.

So in the absence of any retracing of the NZ dollar strength in the near-term, the Reserve Bank may choose to cut interest rates further to stimulate economic growth. This may see the OCR go as low as 2.25% or even 2% from the current level of 2.5%.

So what would that mean for term deposits?  It goes without saying that if central bank interest rates move lower, the rates the retail banks offer for customers to lock their funds into term deposits could also fall. With term deposit rates across the main retail banks already at record lows of between 2% and 4.6%¹ for a 12 month term, that may not be a very appealing prospect for cash investors. Particularly given that income has more than halved over the past 3 years for those relying on term deposits in retirement, as interest rates have fallen from over 8% in 2008 to today’s record lows (see graph).

Perhaps it’s time those investors spoke to an Authorised Financial Adviser about the alternatives available to them which can generate a higher level of income and the potential for capital growth, in a diversified investment portfolio. This will become even more important as inflation begins to rise. Right now, returns from term deposits are providing only a very small positive return (in the vicinity of 1.5% to 2%) after deducting tax and inflation.

Those investors cannot afford for interest rates to move any lower from here!

Source
^{1 www.interest.co.nz}           

By Bevan Graham, Chief Economist, AMP New Zealand

Uncertainty has returned to Europe in the shape of a new President in France and a highly fragmented poll result in Greece, leading to the high likelihood of a second election there. While the results themselves were not that much of a surprise, the uncertainty is around what it all means.

That uncertainty is greatest in Greece where markets are most concerned about the potential for Greece to fail to meet its obligations under the terms of the second bailout, triggering a cessation of funding from the EU and IMF, followed by default and likely exit from the Euro.

There’s still a lot of water to flow under the bridge before we get to that point. The first step will be the formation of a new government which will most likely require a second election, the timing of which appears likely to be mid-June. In the meantime the political rhetoric will escalate as each of the parties vie for a greater share of the vote in that next poll. However, the process of forming a coalition Government will most likely result in a moderation of extreme views. Once a Government is formed there will then be a decision to be made by the signatories to the second Memorandum of Understanding, the IMF and EU, as to whether they are willing to renegotiate the terms of the second bailout. Ultimately the new Greek Government will have a pragmatic decision to make about the relative costs (and pain) of staying in the Euro or departing.

The odds of Greece exiting the Euro have risen. It’s for this eventuality we have been pleased to see work continuing around building the Europe firewall and the implementation of the two ECB tranches of Long-Term Refinancing Operations. Should a Greek Euro exit eventuate it will be messy, but we don’t think it would have the same negative consequences it would have had last year.

In France, President-Elect Francoise Hollande is to be applauded for wanting a better balance between fiscal consolidation (read: austerity) and economic growth. Unfortunately he is three years too late.

When the European fiscal crisis was in its infancy, there was a window of opportunity to solve the problem of unsustainable fiscal policy by taking a long-term approach. That would have required Government’s to articulate credible long-term plans for dealing with the weighty issues of rising fiscal costs such as healthcare, pensions and broader entitlement policies. That proved to be too difficult.

Such an approach would have afforded a better balance between long-term fiscal consolidation plans and the structural reforms necessary to build higher sustainable economic growth. That did not occur and the opportunity to strike such a balance was lost. That’s unfortunate. We have said previously that we are not believers in the concept of “expansionary austerity”. The best solution to high debt is to pay it back. That requires stronger economic growth.

Instead various governments have at various times been subject to market scrutiny of their finances. Many have been found wanting and have been forced into the position of taking harsh near-term measures. Those same measures that politicians couldn’t deal with in 2010 are now being front-loaded. Politicians are now feeling the wrath of a vengeful public. Take note America.

One recent positive development was the recognition of the need for a “fiscal compact”. It is this compact that Mr Hollande wants to re-negotiate. That appears unlikely if recent comments from Chancellor Merkel are anything to go by. It is more likely that we see the development of a separate “growth pact” to run alongside it. Mr Hollande’s call is made doubly difficult by the fact that his pro-growth policy ideas are not shared with most of the rest of Europe, most notably Germany.

It’s essential and inevitable that Europe policy-making strikes a better balance between growth and austerity. Unfortunately that reality may be some time away. The other important factor here is markets. Any softening of commitment to fiscal consolidation will be dealt to harshly, at least until governments have made greater progress towards reduced budget deficits and stability in debt ratios. Unfortunate but true.

Congratulations to Heather Watson from Napier who has won the fabulous 10 day trip in a KEA motorhome featured in the Autumn edition of the Adviser Magazine.

The next addition of the Adviser Magazine will be published in Spring.  If you missed out on reading a copy this time around visit our website to find a copy and sign up for a copy of the Spring edition now. 

Your feedback is welcome

Financial Update is a regular publication published by Spicers Portfolio Management Limited. It discusses topical investment and financial planning issues. A disclosure statement is available on request, and free of charge from you adviser.

Please provide feedback directly to your adviser or email spicers@spicers.co.nz

Disclaimer

The information in this publication is of a general nature only and is no substitute for personalised advice. If you would like advice that takes into account your particular financial situation or goals, please contact your financial adviser.

The information has been published in good faith and has been obtained from sources believed to be reliable and accurate at the time of publication (16 May 2012). The opinions contained in this document reflect a judgment at the date of publication by Spicers Portfolio Management and are subject to change without notice.  Past performance is not indicative of future performance and is not guaranteed by any party.