Many people wonder if rising interest rates are a threat to household savings. People fear interest rates’ effect on their savings because of the connection between interest rates and the money supply.

Interest rates are rising because central bankers are trying to control inflation. The Federal Reserve raised U.S. interest rates by 75 basis points on July 27, 2022. Similarly, the Bank of England raised British interest rates from 1.25% to 1.75% on August 4, 2022.

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Central bankers think increasing interest rates can reduce liquidity (the money supply). Theoretically, reducing liquidity can control inflation by limiting spending. To elaborate, less liquidity means people have less money to spend, so there is less spending and prices fall.

So how does this affect your nest eggs? Unfortunately, there’s no simple answer because interest rates have many effects on the economy.

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Interest Rates vs. Cash

In theory, raising interest rates can help cash holders by limiting inflation.

Inflation hurts cash by cutting money’s buying power. For example, the 9.1% U.S. inflation rate decreases the value of a dollar by 9.1 cents. Hence, if you saved $100,000 in cash in 2021, it is worth $90,900 today.

Thus, limiting inflation can increase the value of cash. If inflation falls and money regains its value.

However, central bankers themselves admit that raising interest rates may not control inflation. For example, St. Louis Federal Reserve President James Bullard told CNBC that the U.S. will need more interest rate increases to control inflation.

Bullard thinks interest rates will need to rise to 3.75% or 4% to control inflation, CNBC speculates. At least three other Fed regional presidents, Loretta Mester of Cleveland, Charles Evans of Chicago, and Mary Daly of San Francisco, agreed with Bullard, CNBC claims.

If Bulllard and his colleagues are right, inflation will keep rising for months, and money will keep losing value. Hence, savers with lots of cash will see their buying power shrink.


Interest Rates vs. Savings Accounts

Raising interest rates will raise savings account interest rates. However, the size of the increase is not enough to make up for inflation.

Bankrate estimates that the average U.S. savings account interest rate was 0.11% in July. Hence, the return on a $10,000 savings account was $11 at the current rate.

Yet, the savings account lost 9.1% of its value, or $910 in buying power, because of inflation. Thus, the savings interest rate could double or triple and have no effect on inflation.

High-interest savings accounts are a little safer. For example, Bankrate claims Bask Bank’s savings account offered a 2.02% interest rate in August. Hence, Bask could reduce inflation losses to 7.08% from 9.1%

However, most savers will still lose money because of inflation. Rising interest rates will not protect the money in your bank account from inflation.


Interest Rates vs. Stocks

The short-term effect of interest rate increases on the stock market is mixed. The S&P 500 rose after the July increases but fell after the June increases.

For example, the S&P 500 rose from 3,921.05 on July 26, 2022, to 4,023.61 on July 27, 2022, to 4,141.23 on August 5, 2022. The Federal Reserve increased interest rates by 75 basis points on July 27.

In contrast, the S&P 500 fell from 3,900.11 on June 27, 2022, to 3,821.55 on June 28, 2022. The S&P 500 didn’t rise back to over 3,936.69 on July 19, 2022. The Federal Reserve raised interest rates by 75 basis points on June 27.

Thus, the June increase had no effect on stocks, but the July increase did. Sometimes the stock market ignores interest rate increases, but they can have an effect.

The July experience shows that continuous interest rate increases could be good for investments based on the S&P Index. For example, exchange-traded funds (ETFs), mutual funds, and money market funds.


Interest Rates vs. CDs

Interest rate increases are not helping certificates of deposit (CDs) resist inflation.

Bankrate estimates the typical one-year CD paid a 0.57% interest rate on August 3, 2022. In contrast, a typical five-year CD paid a 0.69% interest rate on the same day. At the same time, a one-year jumbo CD paid a 0.59% interest rate and a five-year jumbo CD paid a 0.71% interest rate.

The 9.1% U.S. inflation rate will destroy over 9% of the value of most CDs at those rates. Even Bankrate’s best CD rates offer little protection from inflation. Bankrate’s best one-year CD, the BankUnited Direct, paid a 2.5% interest rate on August 5, 2022.

An ordinary money market account provided less inflation resistance than CDs. Bankrate estimates the average money market account paid a 0.12% interest rate on August 5, 2022.


Interest Rates vs. Gold

Interest rate increases can hurt gold prices. Gold prices collapsed after the June 27 interest rate increase. BullionVault estimates the average price of an ounce of gold fell from $1,806.74 on June 28, 2022 to $1,695.61 on July 18, 2022.

However, gold rose after the July 27, 2022, interest rate increase. Gold rose from $1,754.98 an ounce on July 26, 2022, to $1,766.26 an ounce on July 28, 2022. Overall, the price of an ounce of gold rose from $1,695.61 on July 18, 2022, to $1,776.21 on August 5, 2022.

In the final analysis, interest rates will not destroy your savings. But there is no proof that a rise in interest rates will keep your savings safe from inflation either.

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