Financial institutions – whether physical banks, online banks, credit unions or credit card companies that offer online savings – will eventually increase the returns on their deposit accounts if the Federal Reserve continues to tighten monetary policy to fight inflation as expected, but first they will raise lending rates for borrowers. Banks make money on the difference between lending rates and deposit rates, and with near-zero interest rates in recent years, the spread between these two rates was tight.

“As rates rise, banks are hoping to widen that spread so that they can somehow return to more profitable days. This encourages them to raise lending rates more and faster than they raise deposit rates” , says Ken Tumin, founder of DepositAccounts.com, part of LendingTree.

Tumin says the best bet to nab higher rates quickly is through online banking, especially if the Fed raises rates by 0.5% in May markets increasingly expect. During the last round of Fed tightening between 2017 and 2019, he notes, digital banks were slow to respond but eventually caught up. The Fed raised rates to 2.5% and the national average online bank deposit rate rose to around 2.23%. Online banks have more incentive to offer attractive rates compared to physical banks due to lower overhead costs, but also because competition is fiercer since savers can easily switch institutions.

For now, the national average deposit rate for online banks is 0.50%. This compares to a national average for all federally insured banks, including physical banks and online banks, of 0.06%.

Tumin says online savings account rates rose only slightly from last year’s lows of 0.45% as deposit rates held above the short-term target rate. rate, now fixed in a range of 0.25% to 0.5%, for some time now, which means there is little reason to raise yields above this range. Moreover, banks now have little incentive to offer attractive deposit rates, as they have been flooded with funds since the early days of the pandemic.

Online banks instead focus their attention on CD rates, offering higher yields to people willing to tie up their money for a year or up to five years. One-year online CD rates are averaging 0.74% nationally, up from last year’s nadir of 0.44%. The national five-year online bank CD rate average is 1.23% from 0.65% at its 2021 lows. Tumin says these longer-maturity CDs are also influenced by Treasury yields American at two, three and five years, which have increased.

Banks are betting that the Fed’s target short-term interest rate will be higher a year from now, so if they can get people to buy CDs at today’s rates, those levels could look low 12 months from now. . “They see an advantage in offering a bit higher rate for CDs now, rather than raising savings account rates to attract deposits,” Tumin said.

For savers hoping to profit from rising deposit rates, Greg McBride, chief financial analyst at Bankrate.com, recommends against buying CDs at longer maturities. “You want to see interest rates rise more, and you certainly want to see inflation come down significantly before you lock in those conditions,” he says.

Even slightly higher deposit rates are swallowed up by high inflation, he notes, because the real return – the inflation rate minus the deposit rate – is negative. McBride equates real return to the difference between gross pay and net pay.

If savers should probably forget about the savings rates seen in the 1980s, could they hope to see the heyday of the early 2000s when online banks paid close to 5%?

Be careful with wishes, McBride says, noting that at the time the Fed’s short-term target rate hovered around 5%. “If deposit yields come back to 5%, that means the Fed has had to raise interest rates a lot of times and inflation isn’t cooperating, so it could be a hollow victory,” McBride says.

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