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Your savings account's new best friend

August 30, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Over the past few years, bank rates have offered depositors a pretty bad deal. Having fallen to near zero, rates on savings accounts and other deposits have consistently trailed inflation. Now, however, might be the time to give bank rates a fresh look.

No, savings account rates haven't suddenly risen, nor have CD or money market rates. But with inflation suddenly taking a step back, bank rates now represent a better deal than they did just a few months ago.

Getting ahead of inflation

By now you know the story: In response to the Great Recession, bank rates fell to near zero, and they have yet to recover. While they still represent a safe haven in an otherwise very uncertain financial environment, the problem is that bank rates haven't beaten inflation since 2008. That means that while deposit accounts still protect you against losses of principal, the purchasing power of that principal has been steadily eroded by inflation.

This has changed in recent months. Again, bank rates haven't suddenly been resurrected, but inflation has slipped back noticeably. After flaring up in the first quarter of this year, inflation has been negative since, meaning that overall prices have actually declined. This has given savings account rates and other deposit rates a rare opportunity to get ahead of inflation.

A historical perspective on bank rates

In truth, the opportunity for bank rates to beat inflation is only rare in the context of the past few years. From a longer-term historical perspective, it should be perfectly normal.

According to bank rate data from the Federal Reserve and Consumer Price Index data from the Bureau of Labor Statistics, over the past 40 years short-term bank rates have averaged an annual return of 5.99 percent, while inflation has risen at an annual rate of 4.38 percent. This history gives us some idea of what "normal" should look like: Bank rates typically should be running at an annual rate of 1.61 percent ahead of the inflation rate.

Over the four months ending in July, the Consumer Price Index declined by 0.3 percent. If it continued at that rate over the course of a full year, that would result in an annual decline of about 0.9 percent. If prices did decline by that rate, a typical bank rate of 0.10 to 0.20 percent would earn 1 percent to 1.1 percent over inflation. That's not up to the historical standard, but it's not bad from the perspective of recent years.

Even better, consumers who shop for the best interest rates on their savings can find rates of around 0.8 percent. If inflation continues on its recent track, that would put these customers about 1.7 percent ahead of inflation. In other words, they could earn something very similar to the historical return over inflation. For the first time in years, things could be back to normal for those consumers.

With rising oil prices and pressure on food prices, there's no telling how long "normal" will last. Still, whether inflation continues to recede or comes charging back, shopping for the best bank rates will remain a wise approach.

Your responses to ‘Your savings account's new best friend’

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Bill Robins

15 October 2012 at 7:11 am

The Consumer Price Index IS BOGUS! The average person knows better. Gas is up food is up utilities are up realestate taxes are way up. Medical cost are up as well as basic cable. Peanut butter has just about doubled in price as well as corn and products using it.

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