Demand for cash deposits has changed

After nearly 14 years of low cash yields, interest rates are suddenly rising again, and customers are asking how they can benefit from their cash amid rising central bank rates and tough stock and bond markets.

It’s worth remembering that it was only eight months ago, in December 2021, that the UK base rate was at a record low 0.1 percent after the Bank of England cut rates in response to the pandemic. of Covid-19.

At the time, returns on cash deposits were virtually non-existent and banks’ appetite for new cash deposits was very limited. The economy was awash in liquidity, and as recently as February 2021, depositors were putting up funds for a year at a yield of less than 0.1%.

As it happened, the UK economy recovered from Covid much faster than initially predicted and in December 2021 there were early signs that inflation was beginning to rise as a wave of pent-up demand found a market scarce for goods and services.

The UK inflation rate, measured by the CPI, has just been announced at 10.1 percent. In the US, a similar measure of inflation is currently 9.1 percent, while in the Eurozone it is 8.9 percent.

Forecasts are that these inflation rates will increase. Central banks have reacted to inflation spikes by reversing quantitative easing measures and rapidly raising interest rates to slow economies.

The demand for cash is not easy

Changes in the inflation outlook and increases in central bank rates have, in turn, affected banks’ requirements for cash deposits and, as demand and thus the value of deposits in cash have changed, cash management has become a focal point for investors.

Expectations of further rate increases have steepened the interest rate yield curve considerably. Whereas a year ago the yield curve was effectively flat with no premium for one-year deposits over the base rate, more than 1.50 percent is now available.

However, access to this sudden demand for cash deposits is not easy and depositors may not currently realize the true value of their cash.

Banks that moved away from their traditional borrowing and lending model are now having to adapt again to refocus on their borrowing requirements.

Interest rate increases have moved quickly, and some banks have been unable to attract longer-term deposits as investors have been wary and uninspired by the rates they have been offered to tie up their money.

The end of the Libor system at the end of 2021 created a new cash yield curve based on ‘risk-free interest rates’ (RFR). Forward RFRs are calculated by adding previous overnight RFRs.

Some banks are currently using the lower RFR curve as a proxy for Libors when pricing the value of time deposits.

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The value of cash deposits in banks increases the longer they can hold the funds. Instant access products that you can drop at any time are priced substantially lower than notice products or time deposits.

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