What affects term deposit interest rates?

Term deposits are a popular investment choice for people seeking a safe and predictable return on their savings. 

Unlike the stock market or real estate investments, term deposits offer a fixed interest rate over a specific period, so you can be confident about what you will earn. 

However, the interest rates offered on term deposits can be influenced by a variety of factors. Understanding these factors can help you make informed decisions about where to place your money.

The cash rate, set by the Reserve Bank of Australia (RBA), is probably the most influential factor affecting term deposit rates. 

This rate, often referred to as the benchmark or official rate, influences the cost of borrowing money in the economy. 

When the RBA lowers the cash rate, it becomes cheaper for banks to borrow money, which often leads to lower interest rates on loans and deposits. 

Conversely, when the cash rate increases, the cost of borrowing rises, and banks may offer higher interest rates on term deposits to attract savers. 

An expected lowering of the official RBA rate, therefore, usually signals that term deposit rates will also decrease soon. 

Banks and credit unions use the funds deposited by customers such as savings accounts and term deposits to fund their lending to other customers for purposes such as home loans and personal loans. 

If the bank or credit union needs additional funds to support its lending program, it may offer higher interest rates. Conversely, during periods where the bank’s funding exceeds its loan finding needs, it may reduce its deposit interest rates.

The level of competition among financial institutions also plays a significant role in determining term deposit rates.  

Banks and credit unions constantly compete for customers’ deposits, and a competitive market can lead to higher interest rates as each institution strives to offer more attractive terms than its rivals. 

In less competitive markets, or when a few large banks dominate, there may be less incentive to offer higher rates, potentially leading to lower returns for savers. 

Regulatory requirements can also affect the rates offered on term deposits. 

Regulations that require banks to maintain minimum levels of liquidity, for instance, might lead to higher interest rates as banks seek to attract more deposits to meet these requirements. 

The length of the investment term is another crucial factor. Generally, term deposits with a longer-term command higher interest rates, as savers are rewarded for locking away their money for more extended periods.  

This relationship reflects the increased risk to the saver, who cannot access their funds for a long time and might miss out on higher rates offered in the future. 

The size of the investment can also influence the interest rate, with larger deposits often attracting higher rates. This tiered approach allows banks to incentivise larger deposits, which provide them with more capital to lend to other customers. 

How often interest is paid out can affect the overall yield of a term deposit. Accounts that compound interest more frequently, such as monthly rather than annually, can offer a higher effective interest rate over the term of the deposit, leading to a higher return for the investor. 

Early withdrawal penalties can also impact the effective interest rate of a term deposit. If a saver needs to access their funds before the term is up, they may face penalties that reduce the overall interest earned. 

Understanding the terms and conditions related to withdrawals is essential for accurately assessing the potential return on a term deposit. 

In summary, term deposit interest rates are influenced by a complex interplay of factors, including monetary policy, market competition, regulatory frameworks, and the specifics of the investment itself. 

Savers should consider these factors when choosing a term deposit to ensure they are getting the best possible return on their investment. 

It’s a good idea to keep a close eye on the official Reserve Bank rate, as any drop in that (or possibility of an upcoming drop) could herald an imminent decrease in term deposit rates. 

While the cash rate remained steady at the most recent RBA meeting on 19 March 2024, some pundits are suggesting the RBA will be lower it before the end of the year.