Low inflation, high interest rates = a great time for savers

Author: Anna Bowes | Co-Founder –  Savings Champion

2nd July 2024

Inflation finally fell back to the government target of 2% in the 12 months to May 2024, as measured by the Consumer Prices Index (CPI), increasing the likelihood of the highly anticipated base rate cut.

It’s just a matter of when. However, the road to this level of inflation has not been as smooth as hoped and as a result this base rate cut has been delayed multiple times.

Whilst tough news for borrowers, for savers, this is an ideal situation – low inflation and interest rates that are higher than the current rising cost of living.

There are now hundreds of savings accounts that offer interest rates that are higher than inflation – in fact it’s harder to find an account that is paying less than 2%. Although watch out, as there are some out there!

But by shopping around, even those who are paying tax on their savings can find inflation busting accounts, even after the deduction of tax.

With inflation at 2%, a basic rate taxpayer needs to earn a pre-tax rate of at least 2.5% to keep in line with rising costs, for a higher rate taxpayer, they need to earn at least 3.33% gross.

So, with interest rates of more than 5% still available, it’s currently a savers dream.

The savings market has been a little bit unpredictable over the last few months – initially rates started to fall once the base rate stopped increasing last year, especially fixed term rates, then stalled, waiting to see what would happen next.

But the reduction in inflation means that although rates are a bit lower than they were last year, savers are still better off in real terms.

Last August, the top 1-year rates were paying around 6%, whereas CPI inflation was 6.7% – so even non taxpayers were seeing the value of their cash being eroded in real terms.

Although a £50,000 deposit into a bond paying 6% would appear to have grown to £53,000 including accrued interest, in real terms the purchasing power of that money would have fallen to £49,672.

If you were to earn 5% today, although the £50,000 would have earned less actual interest, £2,500 rather than £3,000 – more importantly, the real value would have grown too – to £51,471 – more than keeping up with inflation.

To top off the good news for savers, there has been a lot of competition between cash ISA providers recently, pushing the rates up, even though we are well out of the ISA season. This means that the notorious gap between the top pre-tax bond rates and the equivalent ISA rates is narrowing.

And again, although the interest rates on ISAs look like they are lower, it’s important to look at the bottom line rather than the headline figures.

For example, a basic rate taxpayer who has fully utilised their PSA would earn a net rate of 4%, after the deduction of basic rate tax, on a bond with a gross rate of 5% AER – so if you were to instead put your cash into an ISA, as long as that tax-free account is paying more than 4%, you are better off.

So, to summarise, here are a few top tips for savers:

Shop around to find a better rate

With some accounts still paying less than inflation, if you find some cash in one of these accounts, by seeking the best rates on the market you can instantly increase the pounds in your pocket.

For example, an account in the savings market is paying 1.66% AER (before the deduction of tax) on the first £10,000.

If you have more, the interest rate you earn is diluted as the balance above £10,000 will earn a lower rate of 1.16% AER. Another account in the savings market is paying just 1.70% on all balances from £1.

Currently, you can find an easy access account paying 5% – or even a little more.

This means that if you had £10,000 in the first account mentioned, by switching to another easy access account paying 5%, rather than earning £166 a year gross, you could boost that by over £300 to £500 a year – effectively free money!

Fix it if you can

Of course, easy access account rates are variable, which means that when the base rate does start to fall, you can expect the interest rates on these accounts to come down too.

So if you have any cash that you will not need immediate access to, consider locking some away to hedge against the inevitable rate cuts that are coming. And don’t discount locking away for longer, even though the rates are a little lower.

Assuming inflation continues to keep falling, if you are able to lock up some of your cash for longer, you might feel very pleased with yourself further down the line when you continue to earn above inflation, and have hedged against falling interest rates for the term of your bond.

Don’t wait to use your ISA allowance

More and more savers are fully utilising their Personal Savings Allowance (PSA) with smaller deposits – so earning tax free interest will help make their cash work as hard as possible.

So don’t wait until the end of the tax-year to use up this valuable allowance. The sooner you are earning tax-free interest the better. And rates are very competitive at the moment.

Although this article may contain helpful information and tips, it is not personal advice. You may wish to seek advice from a financial advisor if you are unsure what’s best for your own personal circumstances.