A bank prices a fixed-term deposit off the market cost of funding for that term, which comes from the yield curve. The Reserve Bank describes the curve as the term structure of interest rates, anchored at the short end by the cash rate, with its slope reflecting expectations of where the cash rate will go plus compensation for uncertainty. When the market expects the cash rate to fall, longer points on the curve sit below shorter ones, and longer term deposits can pay less than shorter ones.
There is a widespread assumption that locking money away for longer should always earn more. It is a reasonable intuition and it is wrong often enough to be worth understanding, because the mechanism that breaks it is visible and published.
The curve, and what anchors it
The Reserve Bank defines the yield curve, also called the term structure of interest rates, as showing the yield on bonds over different terms to maturity. It is built by plotting the yield on all government bonds against their remaining term.
The government version is called the risk-free yield curve, because a government borrowing in its own currency is not expected to fail to repay. Its short end is the cash rate, which the Reserve Bank calls the anchor of the curve, on the grounds that it is the interest rate with the shortest term in the economy, being overnight.
Two things describe a curve: its level and its slope. Changes in the cash rate shift the whole curve up or down. The slope is the difference between short-term and long-term yields, and it exists because investors hold uncertain expectations that the future cash rate will differ from today's. The Reserve Bank puts it plainly: the yield on a five-year bond reflects investors' expectations for the cash rate over the next five years, along with the uncertainty associated with that expectation.
That single sentence contains both mechanisms this article needs. The expectation is the first. The compensation for uncertainty is the second, and it has a name.
Three shapes
Normal. Short-term yields sit below long-term ones and the curve slopes upward. The Reserve Bank's reason is worth quoting in substance: bonds with a longer term are more exposed to the uncertainty that interest rates or inflation could rise at some point in the future, and if that happens the price of a long-term bond will fall, so investors usually demand a higher yield to hold them. This shape is often seen during economic expansion.
Inverted. Short-term yields sit above long-term ones and the curve slopes downward. The Reserve Bank describes this as observed when investors think it more likely that the future policy interest rate will be lower than the current policy rate.
Flat. Short and long are similar. Often a transition between the other two, and also seen when rates are low or as a result of some unconventional monetary policy.
On inversion the Reserve Bank is carefully hedged, and the hedging should be preserved rather than tidied away. It notes that in some countries, such as the United States, an inverted curve has historically been associated with preceding an economic contraction, because central banks cut rates in response to weaker growth and inflation, which investors may correctly anticipate will happen. That is a considerably more careful claim than the folk version.
The term premium is a premium, not a law
The slope has two components. One is the market's expectation of average future short-term rates. The other is the extra return investors require for bearing the uncertainty of a longer commitment: the term premium.
The word premium implies it is positive, and usually it is. It does not have to be.
Reserve Bank research decomposing the Australian yield curve into expected future overnight cash rates plus term premia, using government bonds and overnight index swaps over 1992 to 2007, found that term premia declined in level and became less volatile after the adoption of inflation targeting, and were negative toward the end of that sample. A negative term premium means investors were at times willing to accept less than the expected average of short rates in order to hold longer-dated government paper.
If the premium can vanish or invert, then a long rate can sit below a short rate even without a strong expectation of cuts. Two independent mechanisms, either sufficient on its own.
How this reaches a term deposit
The connection is not an inference. The Reserve Bank states it: the yield curve similarly influences the interest rate on savings products with a fixed term, such as term deposits.
The mechanism is easiest to see from the lending side, where the Bank spells it out. For a household fixing a mortgage for three years, the bank calculates the rate by taking the relevant term on the risk-free yield curve, in that case the three-year term, then adding an amount to cover costs and to compensate for the risk that the borrower might not repay.
A term deposit is the same calculation running the other way. The bank is the borrower. It takes the market cost of funding for that term and adjusts for its own costs and its own appetite for money of that maturity. If the three-year point on the curve is below the one-year point, the three-year deposit is cheaper funding to raise, and the offered rate reflects that.
Market reference rates connect the two. The Reserve Bank notes that such rates are based on transactions occurring often enough to be reliably measured, so they serve as benchmarks for pricing bank debt, and names the bank bill swap rate as an important example for bank funding costs. It also observes that cash rate changes pass through to market reference rates almost immediately, and to deposit rates over the following month or so.
The prudential rules step rather than slope
There is a third reason, and it comes from prudential regulation rather than from markets.
Under APRA's Prudential Standard APS 210, a bank's regulatory benefit from a term deposit does not increase gradually with the term. It steps. A term deposit with more than 30 days to run and a real break penalty drops out of the 30-day liquidity stress calculation entirely. Separately, APS 210's stable funding requirement counts a deposit with an effective residual maturity of one year or more as fully reliable funding, where a shorter retail one counts at 90 or 95 per cent.
So a bank's regulatory benefit steps at 30 days and again at one year, and between those points the standard gives it no reason to rise. A five-year deposit delivers no more regulatory benefit than a one-year one, while committing the bank to pay for four more years. What that asymmetry does to an offered rate is not something any source here states, and no publisher is cited for it; it is set out as a structural observation about the rules, not as an account of how banks actually price.
Putting the three together
A longer term deposit can pay less than a shorter one for two sourced reasons, with a third structural observation alongside them.
- The curve's slope reflects expected cash rates. If the market expects the cash rate to be lower in three years than it is now, the three-year point sits below the short end. Sourced to the Reserve Bank.
- The term premium can compress or turn negative, as measured in Australia. It is compensation, not an entitlement. Sourced to Reserve Bank research.
- The prudential rules step rather than slope, at 30 days and at one year. This is an observation about the standard, not a sourced account of pricing behaviour.
None of these is a market anomaly, and none of them means a longer rate is a bad deal. They mean the assumption that longer pays more was never a rule.
Where to look next
- Term deposit rates - the reference page for the category.
- Bond yields - the curve itself, at the points the market quotes.
- Why a bank values a locked deposit more - the prudential rules behind the 30-day and one-year steps.
- Bond yield and cash rate - the two ends of the curve, in glossary form.
Sources
- Reserve Bank of Australia, Explainer: Bonds and the Yield Curve - the definition of the yield curve as the term structure of interest rates, the cash rate as the anchor and the risk-free label, the distinction between level and slope, the statement that a five-year yield reflects expectations for the cash rate over five years plus the associated uncertainty, the descriptions of normal, inverted and flat curves and the reasoning for each, the hedged account of inversion preceding contraction in some countries, the statement that the curve similarly influences fixed-term savings products including term deposits, and the worked description of how a bank prices a fixed-term loan off the relevant point on the curve
- Reserve Bank of Australia, Explainer: Banks' Funding Costs and Lending Rates - the definition and role of market reference rates, the naming of the bank bill swap rate as an important example for bank funding costs, and the relative timing with which cash rate changes reach market reference rates and deposit rates
- Reserve Bank of Australia, Research Discussion Paper 2008-09: A Term Structure Decomposition of the Australian Yield Curve - the decomposition of the Australian curve into expected future overnight cash rates plus term premia, and the findings that term premia declined in level and became less volatile after the adoption of inflation targeting and were negative toward the end of the sample
- APRA, Prudential Standard APS 210 Liquidity (July 2025) - the exclusion of fixed-term deposits beyond the 30-day horizon from the liquidity calculation and the break-penalty condition, and the stable funding factors under which a deposit of one year or more counts at 100 per cent against 90 or 95 per cent for shorter retail deposits
Not financial advice, and not a recommendation of any product or institution. Reviewed by the Tradergy editorial team, September 2026.
Common questions
Why is a 1 year term deposit rate sometimes higher than a 5 year rate?
Because the yield curve can slope downward. The Reserve Bank describes an inverted curve as one observed when investors think it more likely that the future policy interest rate will be lower than the current one. A bank pricing a five-year deposit is pricing five years of expected cash rates, so if the market expects cuts, the five-year point sits below the one-year point and the deposit rate follows.
What is the yield curve?
In the Reserve Bank's words, also called the term structure of interest rates, it shows the yield on bonds over different terms to maturity. The government curve is called the risk-free yield curve, and the cash rate is described as its anchor because it is the interest rate with the shortest term in the economy.
How does the yield curve affect term deposits?
Directly. The Reserve Bank states that the yield curve similarly influences the interest rate on savings products with a fixed term, such as term deposits. A bank prices a fixed term by taking the relevant point on the risk-free curve and adjusting for its own costs and funding preferences.
What is a term premium?
The extra compensation investors require for the uncertainty of holding a longer-dated instrument, over and above their expectation of average future short-term rates. It is a premium, not a rule. Reserve Bank research decomposing the Australian yield curve found term premia declined in level and became less volatile after inflation targeting was adopted, and were negative toward the end of the sample period studied.
Does a longer term deposit always pay more?
No. Two sourced mechanisms break the assumption: the curve's slope reflects expected cash rate movements and can be downward, and the term premium can compress or go negative, as Reserve Bank research has measured in Australia. A third factor is structural rather than sourced, in that the prudential rules step at 30 days and one year rather than rising with term. Longer paying more is a tendency, not a rule.