Interest rates have increased – here’s how to make the most of them

Andrew Bailey, the Governor of the Bank of England, was honest. Announcing the UK’s first interest rate rise for more than three years following November’s meeting of the Monetary Policy Committee, he conceded he did not know where monetary policy was headed next. More rate increases may be needed in the new year to counter rising inflation, he said. But if higher inflation can be headed off, November’s increase, taking the Bank’s base rate from 3.75% to 4%, might suffice.

Mr Bailey can hardly be criticised for his inability to offer savers and borrowers a better idea of what is to come. War in the Middle East, which has sent energy prices soaring, is acknowledged as being  a major factor in the inflation the UK has experienced this year. Back in April, consumer price inflation stood at 2.8%; it has since risen to 3.5% – and the Bank fears it could hit 5% by the middle of next year, forcing it to act. But no-one can be sure how long that Middle East conflict will last.

Events on the ground underline the extent of this uncertainty. When the Bank was doing the analysis that led to its 5% inflation forecast, the oil price stood at around $108 a barrel. By the time, Mr Bailey spoke publicly about the MPC’s decision, the price had fallen below $100, with the results of the mid-term elections in the US raising hopes of a speedier end to the Middle East conflict than previously expected. Such hopes may prove well-founded – or they may be dashed.

Where does this leave savers and borrowers? Well, this interest rate rise – and potentially more to come – will certainly have an impact on your finances. But there are steps you can take to minimise negative effects and accentuate the positives.

Savers should shop around

Interest rate rises are generally good news for savers. It’s an opportunity to earn more on your money, which, if the rise was prompted by increasing inflation, is especially important when inflation may be eroding its buying power. To make the most of this opportunity, however, it’s important to do your research – be prepared to shop around for the most suitable type of account and the most competitive savings rates.

One important debate is the merits of variable-rate and fixed-rate accounts. At times such as now, when interest rates are expected to rise, the latter are often more generous, but you will need to be prepared to tie your money up for an agreed period – and to make a judgement about just how generous that offer is.

At United Trust Bank, for example, you can currently earn a variable rate of 3.9% Gross/AER on an easy access deposit account, or 4.45% Gross/AER* variable in a limited access account where you can only make two withdrawals over a 12-month period to retain the premium rate. Three or more withdrawals in 12 months will cause the rate to drop until the higher rate is reinstated upon the anniversary of the account opening.

Alternatively, the Bank offers a range of fixed-term bonds that set your interest rate for the term of the account. UTB’s one-year bond pays 4.85%* Gross fixed, rising to 5.05%* Gross fixed and 5.10%* Gross fixed on the two- and three-year equivalents respectively.

For savers who are happy to lock away their money for the terms of these bonds, these higher rates look attractive. But if further Bank of England Base Rate increases prompt providers to increase their variable rate products during that fixed term, a variable rate could subsequently pay more interest. Equally though, the rates may remain unchanged or fall. It’s a finely-balanced decision given the uncertain outlook and depends on whether the certainty of locking in the higher rate now for a fixed term is more appealing to you than hoping that variable rates will increase. You should also consider whether having more flexible access to your savings during that same period is important to you.

Another option is a tracker account that automatically moves up and down in line with the Base Rate according to the account’s terms and conditions. The advantage here is you can be confident your variable rate will accurately track the Bank of England’s decisions, rather than increases and reductions being at the discretion of the savings provider. United Trust Bank’s Base Rate Tracker account now pays 4%, for example, though you must give 180 days’ notice of any withdrawals.

Finally on savings, remember that earned interest is potentially taxable at quite high rates. But you can avoid income tax completely in a cash Individual Savings Account (ISA), where you can deposit up to £20,000 a year each tax year. United Trust Bank’s one year Cash ISA for example, pays a fixed rate of 4.95%* a year, tax-free.

Outside an ISA, savings interest may be subject to income tax depending on your circumstances. Basic-rate taxpayers can generally earn £1,000 in savings interest tax-free each year under the Personal Savings Allowance, while higher-rate taxpayers can earn £500. Additional-rate taxpayers don’t get this perk. People on lower incomes may also benefit from the starting rate for savings, which allows up to £5,000 of savings interest to be earned tax-free, depending on their other income.

From April 2027, the rates of income tax on savings interest above the applicable allowances are due to increase to 24%, 44% and 49% respectively. The amount of tax you pay will depend on your overall income, tax band, savings interest and available allowances. For example, assuming they have no other taxable savings interest and can use their full Personal Savings Allowance, a basic-rate taxpayer could earn £1,000 interest a year tax-free. At an interest rate of 4%, that would require £25,000 in savings. For a higher-rate taxpayer, they can earn £500 interest for a year which would require savings of £12,500.

With the possibility of inflation and interest rates remaining unpredictable for some time, there’s no single savings strategy that will suit everyone. But regularly reviewing your accounts, understanding the options available and making sure your money is working hard can help you make the most of your savings, whatever the economy does next.

Product information

Savings rates correct as at 6 November and are subject to change and may fall as well as rise. Tracker rates can move down as well as up in line with the underlying reference rate.  Products may be withdrawn, amended or replaced without notice. Eligibility criteria, account terms and conditions apply.

*AER stands for Annual Equivalent Rate and illustrates what the interest rate would be if interest was paid and compounded once each year. Gross is the interest rate without the deduction of income tax. Interest is paid gross into your account.

United Trust Bank (UTB) has an independent banking license and we are not affiliated with any other banks or building societies. This means that our eligible customers benefit from the full protection provided by the government backed Financial Services Compensation Scheme (FSCS) which protects savers in the event of a bank’s failure. The FSCS protects the first £120,000 of any savings an eligible account holder has deposited with a bank or building society. For joint accounts, each eligible account holder benefits from the same £120,000 of protection. This means that two eligible joint account holders can claim up to £240,000 between them.