Inflation is on the rise and this time, according to most economists, it is not temporary. A year ago, it reached over 4.5 percent. A year, but then everyone argued that it would fall in a moment and it did happen. Today we have an inflation rate of 3.2%. The difference, however, is that economists say this time it’s just the beginning and we’ll quickly hit 4%. And over the next two years, it is unlikely to fall below 3 percent.
Interest on deposits In banks it has been evident that it has been below inflation for several months and that will not change for at least a year. If the monetary policy board raises interest rates in 2022, that could be by a quarter or half a percentage point, not more. It certainly wouldn’t rise to four percent until it was higher than inflation. This would hurt the economic recovery, which from the economy as a whole is more important than the expectations of bank savers, so it definitely won’t happen.
Hence, many people are looking for a way to save their savings from inflation. Not everyone has enough of them to invest in real estate (which is risky, too), and not everyone tolerates investing in the stock market. In this case, retail bonds, especially those whose interest rates depend on inflation, are becoming more and more popular – they appear to be an ideal product to hedge against the devastating effects of higher prices in the economy.
The Ministry of Finance offers ordinary people two types of these bonds: four years and ten years. The shorter ones are definitely more common. Data indicates that we recently invested more than 1 billion PLN in it every month, and its popularity is increasing along with the increase in inflation. This is how the Poles fall into the trap.
The structure of the four-year bond is such that the interest rate is at an annual rate of inflation plus 0.75 percent. But this only happens in the second, third and fourth years of saving. The first is different. Then the interest rate is set and is up to 1.3%.
With inflation rising to more than three per cent, those who invest their savings in these bonds in the first year lose a lot. In subsequent years, they earn 0.75 percent each time, that is, in total within three years they earn 2.25 percent. (These profits do not accrue, because the minister pays us interest every year, which is not automatically reinvested, unless we try to do it ourselves, in addition to buying more bonds). If in the first year inflation is more than 3.55 per cent, then at an interest rate of 1.3 per cent. We are losing more than 2.25% during this time. At this point, the gains from the next three years are less than the loss in the first year.
To put it differently and more directly: If you assume next year inflation is at more than 3.55%. Then it makes no sense to hide from it in a four-year bond. And all of these calculations do not take into account the tax, which will additionally reduce the nominal profitability of such a game. Ironically, then, bonds that protect against inflation better protect against inflation when it is low. When it’s higher, it provides less protection, and when it’s higher than 3.55 percent. Stop protecting at all.
There is also the interest rate on the inflation level plus the bonus only from the second year. This bonus is more in their case, that is, one percentage point. However, the interest rate in the first year is fixed at 1.7%. So here, with inflation at, say, 3.6 percent. We lost a lot in the first year, 1.9 percentage points. The difference is that we don’t have three years, but up to nine years to compensate for these losses, during which we get a total of 9 points. Percentage above inflation, no matter how large or small. In this case, the entire investment will not be meaningless unless, in the first year of saving, inflation reaches 10.7%. (9 points over 1.7%). Fortunately, this will not threaten us for the foreseeable future. Inflation is rising, but not by that much.
The problem is that we invest nearly five times less in 10-year bonds than in 4-year bonds. It’s hard to say why, but I suspect it has to do with the period of the savings freeze. Of all the retail bonds, the three-month bond is the most popular to date, although it gives only 0.5%. every year. However, the investor gets the money back very quickly. I suspect there are far fewer people who are willing to give up their savings for ten years than there are who are willing to do that for four years.
Moreover, not everyone may insist that the rate of return on investment must always be higher than inflation. For some, it suffices to be well above the bank. Everyone else, if they really want to escape inflation, should take a closer look at ten-year bonds.
Raphael Hirsch Economic journalist, award-winning, among others, by the Polish National Bank (Best Economic Journalist 2008) and the Individual Investors Association (Heros Rynku Kapitałowego 2012). Co-founder, among others TVN CNBC and next.gazeta.pl. Currently a fellow at Business Insider and Tok FM.