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Term deposit rates are falling and it looks like some key rates will go below 3% soon. We look at 'real' returns after tax, after inflation, and check how close to negative returns we are

Term deposit rates are falling and it looks like some key rates will go below 3% soon. We look at 'real' returns after tax, after inflation, and check how close to negative returns we are

The US Federal Reserve's rate cut on Thursday morning, New Zealand time, can be seen as a pre-cursor for next week that will see rate reviews in Australia on Tuesday, and then in New Zealand, through the Reserve Bank, on Wednesday (August 7).

In Australia rates were cut only a month ago (to 1%), while in New Zealand the RBNZ cut (to 1.5%) in May. If our Official Cash Rate is cut again next week, (likely to 1.25%) this would put further downward pressure on retail interest rates.

For term deposit rate watchers, the key rate here is 3%.

Here is what most banks offer now:

for a $25,000 deposit 6 mths 1 year
Main banks    
ANZ 3.05 3.00
ASB 3.05 3.00
3.05 3.00
Kiwibank 3.15 3.10
Westpac 3.05 3.00
Other banks    
Co-operative Bank 3.00 2.95
Heartland Bank 3.15 3.20
HSBC Premier 2.70 2.70
ICBC 3.10 3.15
RaboDirect 3.10 3.20
RaboDirect 3.10 3.00
3.00 3.00

When rates fall next, they are likely to go below 3%. 

Until now, banks have resisted passing on all the RBNZ rate cuts to borrowers, holding some for term deposit investors.

But with the OCR now at 1.50% and threatening to go to 1.25% soon, it is hard to see banks passing on zero of such a cut to mortgage borrowers, so that will mean the next RBNZ cut will drag the key TD rates below 3% for the first time.

If they do, that will signal a new record low.

Given that inflation is now 1.7%, and marginal personal income tax rates are 17.5%, 30% and 33% depending on income levels, the after-tax, after-inflation returns (that is, real returns) are now under severe pressure.

  marginal Interest
  tax rate rate
Before tax return   3.00%
- return after tax, tier 1 17.5% 2.48%
- return after tax, tier 2 30.0% 2.10%
- return after tax, tier 3 33.0% 2.01%
     
Before tax return   3.00%
- return after tax, tier 1, after inflation 17.5% 0.78%
- return after tax, tier 2, after inflation 30.0% 0.40%
- return after tax, tier 3, after inflation 33.0% 0.31%

After-tax, after inflation returns may not turn negative even if the RBNZ cuts rates by -25 bps on Wednesday, but it will be academic. The current +31 to +78 bps real returns could dip to +10 to +60 bps depending on your tax bracket, but both are "next to nothing" on this basis.

However, another subsequent cut by the RBNZ will drive these real rates negative.

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29 Comments

Retired-Poppy, you've previously said that your life savings are in a term deposit that you negotiated back in Jan 2018. When does it expire?

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lol! Due Diligence, it seems to me that you're nervously consumed studying those who are cashed up to notice where your own finances are headed. I have just under 3-1/2 years to run at 4.26% paid monthly, and nope it's not my entire life savings as I have a sizeable Kiwisaver. You just made that up. Do you recall the prediction I made in the New Year? It was that the OCR would be 1.0% by year end. I'm financially prepared, are you? Are you ready for an OCR of -0.75% and the resulting fallout on property/rents? Time for a financial health check perhaps.

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Switzerland currently has a bank rate of -0.75% and a 3 year fixed mortgage over there is 0.5%. At that mortgage rate property would have to fall in price by 70% and I would have to pay my tenants to stay in my renters before I would even be close to being in trouble.

I'm not only prepared, I am waiting with bated breath!

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HeavyG, Switzerland is a safe haven. Big global players are happy to pay up knowing their money is safe. Once our OCR drops to -0.75, are you capable of explaining how NZ would be regarded internationally as a "safe haven when there's a global "risk off" mood, the NZD falls and the Swiss franc rises. What will the global situation look like?

On the slim chance you're not making this up, I suggest that not many Landlords would be financially prepared to pay their tenants to occupy. You're truly one of a kind. On a percentage basis, how many Landlords do you think are prepared to do this?

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Same mortgage rates for Denmark or Japan which also negative bank rates. Take your pick.

You're predicting 1% OCR for end of year. What are picking as the 3 year mortgage rate end of year if OCR is at 1%?

As for my statement I would need to be paying my tenants to occupy my renters, that was obvious (or so I thought) tongue in cheek. That you believe things may get so bad that this could be a reality shows your predictions for the future are dire indeed! Some new Labour policy maybe?...

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"What am I picking as the 3 year mortgage rate end of year if OCR is at 1%? As you know, eighty percent of bank funding is sourced by way of retail deposits, it depends on what banks can get away with offering on TD retail rates without bleeding deposits. Put it this way, any reduction in mortgage rates won't come near to compensating you for your capital losses. Personally, as I'm not a borrower, mortgage rates is not really my concern.

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From the US Fed - "Downside Risks - "Slowing global growth and elevated trade tensions are already hitting U.S. manufacturers. And there’s a risk that could get worse. What’s more, inflation remains stubbornly below the Fed’s 2% objective.“Continued below target inflation could lead to a worrisome and difficult-to-reverse downward slide in longer term expectations,” Powell said.

https://www.bloomberg.com/news/articles/2019-08-01/powell-suggests-fed-…

Sounds like Powell is discussing the risk of deflation. As the economy weakens here, the inflation rate is likely to as well. Lower deposit rates are likely to be still attractive.

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You were happy enough to argue a -0.75% OCR rate will not equate to low mortgage rates (0.5% to 1% for 3 years) but when asked about an OCR rate at 1% you become all shy?...

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HeavyG, your comment speaks more of a debtors wish. Of course a lower OCR rate could equate to lower mortgage rates. What that rate is is entirely up to the banks and other economic variables. A -0.75 OCR might unearth some unintended consequences whereas through banks needing to source funding other than domestic, it might hold mortgage rates at higher levels than comparative OCR/mortgage rates experienced in Switzerland.

Why am I shy again?

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3.5 years? Going to be a nervous wait no doubt. Sweaty palms and a stiff upper lip Poppy.

I don’t sell, so I’m really just interested in rents and interested rates. Interest rates are going down and rents are going up.

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Sweaty palms? Hardly. BTW, can you clarify something? by Due Diligence | 30th Jul 19, 11:43am "I'm not BLSH, that guy was an absolute nutter"

Have you labeled him/yourself an "absolute nutter" because of his/your predictions that Auckland HPI would finish 2019 at +1%, the RBNZ would keep the OCR at 1.75% all year, that he/you owns a spec rental in Papamoa or is it all three reasons?

Should those closest to him/you be concerned that as time passes and this downturn deepens, is there a risk of evolving into an even bigger "nutter"?

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He was a madman, no doubt about that. Sometimes there’s a fine line between genius and crazy though. Perhaps he flew too close to the sun, now banished to 403 land forever.

I’ll certainly check in on his predictions at the end of the year. Most are proving to be insightful. Anyone wise enough to act on his A2 Milk and Infratil predictions would be very happy today. I wonder how much he bought himself?

https://www.interest.co.nz/news/97512/will-current-prosperity-last-will…

I see rents and house prices in sunny Pāpāmoa Beach have been climbing consistently.

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The lower interest rates really hurt the elderly living off the interest, but on the flip side its not so bad for someone saving for a deposit for a house in Auckland as is the money keeps its value in a falling housing market the benefits of buying at a lower price far exceed any interest gained on a TD.

If you look at the median being somewhere around $850K and prices are down generally around 5% in the last year or so, and that equates to a $42500 saving already.

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There is also a negative for those saving for a first home. Typically they will have reasonable amount of funds in a relatively conservative KiwiSaver fund with a heavy weighting in cash - typically returns on cash in KiwSaver are less than half bank term deposit rates.

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It would be interesting to know how many people are in the former category - having their passive income off interest getting crushed, and how many are in the second category - yay we can service more debt.
There is evidence out of the US (check the wolfstreet blog) that rate cuts kill off the spending sentiment of the elderly as their passive income dries up and in turn their lack of spending depresses economic activity, so what you actually get with rate cuts is a net reduction in GDP growth. See negative rates in Europe and Japan for evidence of that that. I've yet to see any rate cuts anywhere that actually stimulated ECONOMIC ACTIVITY. What usually happens is that big corporates borrow money on the cheap and do share buybacks, and what you get is record stockmarket valuations and assets bubbles popping up here there and everywhere. Then you get cash controls (see France Spain et al can't do a cash transaction over 1000 Euros, to stop people hoarding cash as interest rates dive into negative territory as people try and save their purchasing power, also see new legislation in Australia pushing for the same thing). It's full spectrum attack on a way of life that most of us equate to living in NZ all in the name of trying to satisfy a model that equates borrowing with growth. It's nuts. The future will be very different to what has come before. Having these banks running the show is like living with one of those diseases that just get worse and worse until you need three people to help you piss.

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Milford Funds - Conservative & Diversified Income Funds. Gonna have to go there now!

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With the rates getting so low, it doesn't matter very much at all if you are on the wrong tax rate. Either for you or for the govt.

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A valuable article.
For those conservative risk aversion retirees who planned on 6 to 7% return on their term deposits this will mean a considerable dilemma - either a considerable and reducing cut in their income, or look to more higher more risky returns.
For this group, the situation will being causing considerable concern.

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Printer8, does it bother you greatly if retirees get to enjoy spending some of their principle savings when paid work finishes? Your viewpoint of retirement is best described as something to die from as opposed to something to die for. Why should retirees be worried? Many are debt free, mortgage free and they have a considerable principle sum in which they derive their (declining) return. When one pops their clogs, one can't take the principle with them. Why can't retirees simply draw down on the principle? Isn't that the idea behind saving for retirement?

Cheer up.

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PR
As usual - rubbish once again.

Subsequent comment: I see you acknowledge that in editing your original posting.

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translated "RP raised some valid points to which I cannot factually argue"

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RP,

My last post before my flight to Singapore. The word is principal in the context of your post,not principle. Am sure you have high principles in the investment of your principal. No need to thank me,it’s my pleasure.

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Words mean what ever RP wants them to mean. You can thank him later.

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Thanks linklater01, good spotting - my bad :)

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Orr said rightly depositors will just have to buy into Bond funds.

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If depositors start withdrawing large amounts of cash from the banks to invest elsewhere, I wonder what the banks will do to attract the money back. David Chaston stated in an earlier article that our banks really, really need to retain those cash deposits. It could be quite interesting!

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Exactly. Banks might find their profits coming under immense pressure. If people start investing in safe deposit boxes, things could get even trickier. https://www.stuff.co.nz/business/114328314/when-interest-rates-fall-bel…

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Stocks will be up, up and away...

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I expect stick for this but here goes.
Inflation next year is going to take off and interest rate decisions will be v hard to make (ie increases)
Why? Because of food prices. USA and China have crises re crops re floods in USA and pig decimation by swine flu. These are going to have huge knock on effects on world food prices, especially given climate effects fo warming. Deflation will be followed by high inflation and no one expects it (Mauldin hints at it though)
I expect inflation in USA and China to go to 5% minimum. Then what for interest rates? In UK in 2012-13 BoE refused to raise them when inflation temporarily took off, as did not think economy could take it. Central banks have been trying to create inflation for 12 years now. They will get it, just when they have given up. tariffs will asset this. Only solution to world debt levels is erosion by inflation or default. We are starting to see latter in some planks splintering in China and Australia. Inflation will follow.

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