1-Month CD Rates vs. Inflation

Perhaps you thought it odd when bank rates dropped in half in the first six months of 2008. When they dropped below 1% in early 2009, you knew that was unusual. Then, when bank rates fell to a quarter of 1% in the summer of 2009, you might have felt like Alice in Wonderland, watching objects suddenly appear to shrink. This is no Wonderland, though, and conditions for bank rates got even worse at the end of 2009.

The real problem is that while bank rates may still be shrinking, inflation has started to grow. The combination has created a very unusual situation.

CD Rates Go Under Water

For most depositors, what ultimately matters is the interest rate they earn over and above the rate of inflation. To illustrate how bank rates relate to inflation, MoneyRates.com looked at the history of 1-month CD rates, available from the Federal Reserve going back to 1965. These CD rates are short-term enough to be a good indication of trends in other bank rates, such as savings account rates and money market account rates.

Since 1965, 1-month CD rates have ranged from 0.18% to 19.24%. But with inflation also widely variable in that time period, you can't tell from CD rates alone whether depositors are getting a good deal. For example, there have been times when 1-month CD rates have exceeded 10%, but inflation was even higher. In those cases, depositors were actually losing purchasing power. In other cases, 1-month CD rates have been below their long-term average of 6.27%, but very low inflation rates have provided depositors with a solid increase in purchasing power.

In the last six months of 2009, what really changed in this relationship was not so much CD rates as the prevailing rate of inflation (based on the trailing 12-month change in the Consumer Price Index provided by the Bureau of Labor Statistics). Sure, CD rates continued to fall, but only slightly--1-month CD rates dropped from 0.28% to 0.18%. The big change, though, was that the prevailing rate of inflation rose from -1.2% to +2.8%.

This swing of 4% in the prevailing rate of inflation effectively swept bank rates under water. While it is not normal for 1-month CD rates to be under the rate of inflation, it certainly isn't unheard of--it's happened about 22% of the time since 1965. The odd part is that this usually happens during periods of high inflation. In contrast, 2009's inflation rate of 2.8% is clearly below average.

The problem with bank rates being under water during a period of low inflation is that you can't realistically expect inflation to fall, at least not by much. The best hope, then, is for interest rates on CDs, savings accounts, and money market accounts to finally rise.

Time to Keep a Close Eye on Bank Rates

With most deposit rates now under the rate of inflation, depositors have to keep a closer eye than ever on bank rates. Finding above-average interest rates is crucial for anyone trying to keep up with inflation. Also, it is important to know which banks will be first to respond to the rising inflation environment by offering higher deposit rates. MoneyRates.com will continue to frequently update rates from hundreds of bank products, so you can stay apprised of which products give you the best chance in the fight against inflation.

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