Bank Rates May Have to Change Soon in Response to Inflation
November 04, 2009
When Will Bank Rates Start to Follow Inflation Trend?
The most recent Consumer Price Index (CPI) release indicated that inflation increased by 0.2% in September. This is a seemingly modest number, but it should be enough to raise a caution flag for bank depositors. With bank rates mostly languishing in sub-2% territory, there is little room for error should even moderate inflation make a comeback.
Deflation in the Rearview Mirror
Over the past year, even bank rates in the 1% to 2% range have represented a pretty good deal, because deflation (i.e., negative inflation) has exceeded 1%. In purchasing power terms, that's like getting an additional 1% on top of the stated yield. Indeed, for the 12 months ending September 2009, the change in the CPI was -1.3%. On the surface, it would appear the deflationary trend remains in place, so what is there for depositors to worry about?
The problem is that, while the overall 12-month CPI trend still shows deflation, the CPI has been positive in 4 out of the last 6 months and hasn't had a negative reading since March. It appears that the deflationary period is starting to fade in the rearview mirror.
Looking forward, a return of even moderate inflation would overwhelm current bank rates. If the September CPI number were to persist for an entire year, that would mean an annual inflation rate of 2.4%--low by historical standards, but higher than current savings account interest rates and higher than short- to intermediate-term CD rates.
What to Do About Bank Rates
What should you do about the prospect of higher inflation? You could move out to longer maturities to find higher CD rates, but this would only increase your risk by tying up your funds if inflation comes back a little stronger. Instead, it might be wise to go in the other direction: stay short and flexible in a savings account. Savings account interest rates should adjust more quickly than if you have to wait for a CD to mature. Eventually, bank rates will have to react to the inflation trend, and when they do, you don't want to be left behind.
Source:
Consumer Price Index Summary • Oct 15, 2009 • US Bureau of Labor Statistics: http://www.bls.gov/news.release/cpi.nr0.htm
