Deposit Rates vs. Inflation: a Battle of Attrition

By Richard

There hasn't been much inflation in recent years, but there's still been enough to eat away at the purchasing power of savings accounts. That trend continued with the latest release of the Consumer Price Index (CPI), which showed that prices increased at a seasonally adjusted rate of 0.2% in September, bringing the inflation rate for the past year to 1.2%.

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Lowering the inflation hurdle

Inflation is the hurdle that savers and investors have to get over before they can start really making money -- or more accurately, start gaining purchasing power. Normally, you can expect that inflation hurdle to be around 3 or 4%, but over the past year that hurdle has been much lower.

In one of the economic releases that was delayed by the government shutdown, the Bureau of Labor Statistics put out the September CPI report on October 30. Though the gain of 0.2% was mild, it was a tick up from August's 0.1%.

Energy was the chief culprit in pushing prices higher, as this segment of the CPI increased by 0.8% during September. In contrast though, energy prices have actually declined by 3.1% for the one-year period, which has been an important influence in keeping inflation moderate. Furthermore, there is reason to believe that energy will continue to have a dampening effect on inflation when October's figures are released, as oil prices declined through most of the month.

A symptom of a weak economy

Even though the inflation hurdle has been particularly low over the past year, savings accounts have still failed to clear it. While the inflation rate stands at 1.2%, savings accounts are yielding an average of just 0.06%. Money market rates are not much better, and even five-year CDs are failing to beat inflation, with an average yield of just 0.75%.

The underlying problem is that those nice low inflation rates are a symptom of a weak economy. Demand is so weak that companies lack pricing power, which results in low inflation. That same lack of pricing power discourages companies from expanding and hiring, which in turn further weakens the economy.

Like low prices, low bank rates are also a product of weak demand. In a lackluster lending environment, banks don't have a particularly great demand for capital. Meanwhile, they've had no trouble attracting deposits, even at minimal interest rates. So, awash in deposits they have little productive use for, banks don't have a strong incentive to raise their interest rates.

Thus, even low inflation is hard for savings accounts to beat. While you may not beat inflation, you can take a much bigger dent out of it if you shop around for the most competitive bank rates. Unless weak demand drives inflation even lower, or until stronger demand pushes bank rates higher, taking a bigger dent out of inflation may be the most you can ask for.

The original article can be found at rates vs. inflation: a battle of attrition