Will rising interest rates lead to a massive reorientation of household investment priorities?

Inflation continues to encourage a long-established propensity to save in France

The surge in prices is continuing to encourage a deeply rooted propensity to save in France despite the volume of surplus savings already amassed during the pandemic estimated at an aggregate total of about €175 billion between 2020 and 2022. As highlighted in the November 2022 poll carried out by the BPCE-Audirep barometer survey, inflation has become the second most important reason driving French people’s desire to save, with most of them considering that they possess insufficient precautionary savings to ride out the current crisis. This finding is supported by the survey of short-term economic trends focused on French households conducted in December 2022 by the INSEE National Institute of Statistics and Economic Studies: both the advisability of saving money and highly exacerbated price rise expectations before and after Russia’s invasion of Ukraine remain extremely acute in comparison with the averages in previous surveys. We are also observing a simultaneous increase in unemployment-related fears – albeit at a level still lower than the past average – liable to accentuate precautionary savings behavior as the economy gradually runs out of steam. The household savings rate is expected to reach 16.7% in 2022, considerably higher than its pre-crisis level of approximately 15%, even though it remains lower than the level reached in 2020 (21%) and 2021 (18.7%). It rose to 17.8% in the fourth quarter of 2022, after reaching 16.6% in the third quarter, driven by the revival in household purchasing power in the second half of the year. 

These fluctuations can chiefly be explained by the fact that French households – notably those in the more affluent social strata largely responsible for the savings surplus and presenting a lower than average propensity to consume – want to restore their real cash balances in response to inflation (and as long as they remain confident in the currency). What is more, despite the rise in nominal interest rates, the insufficient rates of return – and, above all, the risk that higher inflation will erode the real value of their financial assets – is pushing them to continue saving at levels that are all the higher as these affluent individuals anticipate future tax hikes in response to deteriorating public finances. Against a backdrop of uncertainty and a sense of weariness induced by the never-ending succession of rapidly emerging crises, this difficulty to bring down the savings rate exacerbates the ‘stagflation’ situation that currently seems to characterize the French economy: a situation similar to the one experienced in the 1970s marked by high inflation, persistently weak growth, and rising interest rates. 

Measured in terms of surpluses (flows excluding interest and capitalization of interest), financial investments – whose estimated surplus compared with the 2018-2019 average stands at nearly €146 billion between 2020 and 2022 – have followed the same trend observed in the savings rate. They reached an absolute record of €138.4 billion in 2020 before gradually declining from €111 billion in 2021 to €93 billion in 2022, while remaining well above the average of €44.4 billion per year (in constant euros). 

Continuation of excess saving and increased arbitrage in 2022

In the current economic situation, the aggregate net inflow of household financial investments from January to October stood at €71.7 billion (excluding securities), reflecting a decline versus the same period in 2021. It still exceeds the January to October average in 2018-2019 by a total of €15 billion. However, above and beyond the typically negative seasonal performance, the month of October saw outflows of €12.1 billion, a much higher level than the average noted in October 2018-19. These outflows chiefly reflect withdrawals from sight deposit accounts (-€15.8bn) and from PEL home savings schemes (-€1.5bn) in favor of term deposits (investments held to maturity: +€3.4bn) and passbook savings accounts (+€2.2bn) although deposits on the CSL savings account declined by -€0.6bn. The upward trend in interest rates seems to be attracting greater interest in term savings accounts where inflows, which moved back into positive territory in March, have gathered pace since September. What is more, the rise in interest rates paid on LEP popular passbook savings accounts to 2.2% in February and subsequently to 4.6% in August, and the higher rates of interest paid on Livret A and LDDS Solidarity & Sustainable Development passbook savings accounts (1% and 2% respectively) have triggered an increasingly marked reallocation of household savings. Life insurance made a negative contribution (-€0.3 billion), depressed by euro-denominated products (-€2.6 billion). In contrast, a €1.4 billion rebound was noted in November (€1.7 billion in unit-linked products, -€0.3 billion in euro-denominated products) after five months of lackluster performance. Unit-linked products were also boosted by the development of PER retirement saving schemes. Overall, there has been a gradual shift away from the most liquid and marketable savings towards higher-yielding products, with a relative shift away from sight deposits, life insurance and PEL home savings schemes towards regulated passbook savings accounts and a recent surge in term deposit accounts. Aggregate sight deposits seem to have made more moderate progress of €18 billion, with a slowdown in fund flows without withdrawals, owing to the ‘real cash holdings’ effect. These arbitrages still provide meager protection against inflation considering that real yields remain negative with inflation at an average annual rate of 5.2%, and reaching 5.9% per year in December 2022.

Regulated rates approaching a psychological threshold

After more than three years of relative stability in interest rates (as viewed by households), the BPCE L’Observatoire survey conducted in November last year reveals a radical change in French people’s perceptions. Whether for Livret A passbook savings accounts, real estate loans or life insurance, the French consider that rates rose by approximately 100 basis points in the second half of 2022. This rise from 2% to 3% for home loans, as perceived by the French, has already prompted three-quarters of households with real estate projects to reconsider their plans either by postponing, cancelling or modifying them. 

As far as savings behavior is concerned, this new implicit rate curve for households (with the Livret A at 2% and life insurance at 3%) has led to an in-depth reappraisal of tax-free passbook savings accounts. These accounts, which are better rated than all other types of investment and rank second only to the acquisition of a principal residence, have seen a readjustment in their ‘value in use’ with a greater emphasis on their status as a ‘return-generating asset’ alongside their reputation as safe, liquid, and easy-to-use investments. When asked about their intentions to make new deposits or transfer funds to Livret A and LDDS passbook savings accounts, responders clearly revealed the sensitivity of households to interest rates: in February 2022, 31% of French households planned to invest in these accounts when they were earning 1% interest; in June, assuming the interest rate was 1.5%, this percentage rose to 46% and, in November, 58% of households said they planned to invest in these accounts should rates rise to 3%. Responses broken down per level of income and asset ownership also revealed that members of the most affluent social strata, accounting for the greater part of earlier surplus savings, were by far the most highly sensitive to the reallocation of their investments. Finally, a typology of Livret A account holders drawn up by BPCE L’Observatoire reveals that most of these arbitrage decisions are made by savers whose average holdings are significantly lower than the maximum investment ceiling. 

This increasing sensitivity on the part of savers can partly be explained by the fact that their arbitrage behavior is not linear. As revealed by the BPCE-Audirep barometer survey, the median rate of return capable of pushing people with money sleeping on their current accounts to invest these sums is close to 3.5%. This rate can be likened to a psychological threshold at which savers consider that the promised reward justifies the effort of seizing an arbitrage opportunity. The closer a nominal rate approaches this threshold, the greater the probability that an arbitrage decision will be triggered, this probability being very low when interest rates are less than 1.5%.

The comparative econometric analysis of the impacts of the last two interest rate hikes confirms the progressive nature of these arbitrage decisions. With regard to the two recent increases in regulated rates on February 1 and August 1, 2022, the sensitivity of savers seems to become more pronounced as Livret A and LEP rates rise above a psychological interest rate threshold of approximately 2.5%. This non-linearity emerges from an analysis of how the impact of these two events differ over a 3-month period when compared to previous trends. By proceeding on an ‘all things being equal’ basis, i.e., by extrapolating the amounts if the two events had involved the same increase in interest rates (+100 basis points for the interest paid on Livret A deposits, +240bp for the LEP rate), it is possible to compare the impact of the two increases term by term and in a uniform manner. In both cases, the sum of arbitrages was zero, resulting in neither additional flows nor a reduction in investments. It appears that the first rate increase enabled the LEP (at 2.2% versus 1% for the Livret A) to be competitive with the Livret A and the LDDS for low-income customers. The impact of these products was therefore much lower than in previous years. Regulated passbook accounts also benefited considerably from the accelerating trend in withdrawals from PEL home savings schemes. The usually expected arbitrage decisions were modified for life insurance (nil, owing to the momentum of unit-linked funds through the PER retirement savings schemes) but remained relatively consistent for sight deposits. The second rate hike (Livret A interest rate raised to 2% and the LEP rate to 4.6%) was more significant, as it substantially increased the amount of arbitrage decisions in favor of regulated passbook savings accounts, while weighing much more heavily on PEL home savings schemes and, particularly so, on sight deposits and life insurance. 

Regulated rates, the risk of large-scale arbitrages in 2023

On February 1, 2023, the calculation formulas are expected to lead to an interest rate of 6.1% for LEP popular passbook savings accounts and a rate of 3.3% for the Livret A unless the 0.5% increase floor is applied, which would raise the latter to only 2.5%. The decision to follow the rule and limit the increase to 2.5% or to raise the rate to 3.3% is eminently political in nature. The prospect of a frequently contemplated increase to 3.3% will not be neutral in its effects, however. It would be detrimental to the financing of social housing and would raise the significant risk of generating potentially violent inter-asset arbitrages owing to the major non-linearity effects generated as rates approach a new psychological threshold of 3.0%/3.5%. It should be remembered that, on the basis of econometric models established in the past, an increase in regulated rates of only 30 basis points would have (all other things being equal) an impact of €11.2 billion on aggregate passbook savings accounts, of which €4.2 billion for the Livret A, more at the expense of life insurance (-€6.5 billion) than of sight deposit accounts (-€3.8 billion). The impact on the LEP passbook account would, in principle, result in inflows of +€750 million, with funds coming chiefly from the Livret A, and possibly from sight deposits and LDDS Solidarity & Sustainable Development passbook savings accounts. However, the impact – which should logically be multiplied by a factor of four – would probably be spread over a much longer period of time owing to the inertia of arbitrage behavior and the blurring effect of soaring inflation (real returns remain deeply negative), the speed and scale of successive regulated rate increases, the specific impact of the higher increase in the rate of return on the LEP passbook account, and the rise in interest rates overall.

In 2023, financial investments are not expected to return to their pre-crisis levels even if they continue to decrease owing, firstly, to the decline and subsequent weakness of household purchasing power and, secondly, to the expected slowdown in the distribution of real estate loans, a trend accentuated this year. Arbitrage between financial products (which, it is true, is still characterized by a wait-and-see attitude), a focus on security and on the ready availability of funds at the expense of risk, will nevertheless be disrupted by the scale of the sudden changes in regulated rates and by the growing relative gain conferred by tax exemption. The combined effect of an off-market rate and an additional net return of 30% (compared to assets subject to the single flat-rate withholding tax in France) therefore contributes doubly to the relative competitiveness of Livret A, LDDS and LEP passbook savings accounts. The closer regulated rates approach, or exceed, a psychological threshold of about 3%, the shifts towards these products will be correspondingly more massive, incurring significant risks of unquantifiable offer effects on LEPs, taxed passbook savings accounts, money market funds and bonds to the detriment of sight deposit accounts, PEL home savings schemes, other passbook savings accounts and life insurance denominated in euros. In particular, despite a ceiling that is frequently reached, the number of LEP holders, which is close to 7 million, would offer significant room for growth as it remains much lower than the number of potential beneficiaries (close to 15 million) according to the 2021 Regulated Savings Observatory (Observatoire de l’Epargne Réglementée). We also expect to see a continuing progressive shift from the most liquid and immediately available segments to investments whose returns provide savers with initial protection against inflation thanks to the successive increases in regulated rates.

Pensions reform: the worried ‘wait and see’ attitude of working people

Reform of the pension system is a source of concern for the French, particularly among those aged 50-64 and among public sector employees while a large minority is skeptical about its actual implementation or impact. The argument that it could help to ensure the sustainability of the current system convinces only 20% of the French, especially retirees. Even if the political stakes of the reform seem to have shifted to the question of retirement age, many people worry about the size of their pensions, even if this concern is expressed by a minority, with the majority of French people choosing to adopt a wait-and-see attitude and remain uncertain as to the outcome.

The inconsistency of political announcements, however, is having little impact on French people’s concerns about retirement. Regardless of the period, 65% of working people – a proportion that has remained fairly stable for several years now – say that they worry about the future level of their pensions and 70% consider it a priority to save for their retirement. Faced with the multiple challenges of longer life expectancy, saving for retirement is still perceived in the positive light of a ‘choice for autonomy.’ Thanks to the so-called ‘Pacte’ law on Business Growth and Transformation, individual retirement savings schemes – already subscribed to by 17% of French people with 20% considering taking one out according to the BPCE-Audirep barometer survey – have become an attractive solution to a great many alongside investments in real estate and life insurance.