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Why are savings interest rates so low and when will they go up?
Updated: Friday 25 November, 2011
By Martin Fagan
Savers are suffering with pitiful interest rates at the moment. We look at why this is and when things might improve…
Savers are having a rough time of it at the moment, with interest rates lingering at pitifully low levels.
The average interest rate on the best-buy instant access savings accounts was 2.42% as of 12 May, 2011, according to independent financial information company, Moneyfacts.co.uk (www.moneyfacts.co.uk).
But when will interest rates start to rise again? In this guide we will answer this question and show you what to do now to get the most from your savings.
- Why have savings rates been cut?
- When will savings rates go up?
- Top tips for getting the best return on your savings
Why were savings rates cut?
Savings rates have basically been cut because, in March 2009, the Bank of England cut its base rate to 0.5%, the lowest level since records began. Why must savings rates follow the base rate? What follows is a (very simplified) explanation.
Banks and building societies pay savers interest when they deposit money with them, then charge other people to borrow this money. The rate at which they lend money must be higher than the rate they offer to savers in order to make a profit.
The rates all lenders charge to borrowers depend on economic circumstances and the current credit market. One factor that reflects and affects the credit market is the Bank of England base rate, and lending rates will generally reflect the base rate and may rise and fall accordingly.
As recession hit the UK, the base rate was cut six months in a row, taking it from 5% in October 2008 to 0.5% in March 2009. Since then the base rate has remained unchanged and this low rate means banks will be earning less interest from some of their lending, for example tracker mortgages. If they are lending at a lower rate of interest, it means that, to make a profit, they must offer savers a lower rate of interest to deposit their money - this is why savings interest rates have dropped.
Due to the credit crunch many financial institutions are finding the cost of funding their operations more expensive and that is another reason why the returns they are giving to savers are falling.
This explanation should also ring true for building societies, and while there are additional complicating factors when it comes to banks (like toxic debt), the principle remains the same.
When will savings rates go up?
While it’s unlikely that rates will remain this low forever, it is almost impossible to predict when the base rate will rise, and thus when savings rates will improve. However, the Bank of England’s quarterly inflation report for May 2011 predicted inflation would hit 5% by the end of the year and that interest rates may have to rise as a result.
However, while the average rates on savings accounts are fairly low, there are some gems among the pebbles and, if you do have savings, finding the best paying account should be top of your list of things to do.
Top tips for getting the best return on your savings
It is definitely still worth saving - no one knows what the future holds and it’s important to be prepared. If you want to get the best rate on your savings, make sure you do the following:
- Fill up your ISA - Because of the great tax benefits, your ISA should be the first destination for savings
- Investigate savings rates at your local building society - Smaller building societies often offer the most attractive rates
- Look at fixed-rate accounts - If you don’t need access to your cash for a year or two, locking them up in a fixed-rate account could earn you better returns than instant access accounts
- Look at regular savings accounts - If you are just beginning to save, or are willing to drip feed your savings into an account, then you should definitely check out regular savings accounts - in return for regular deposits these pay some of the best rates on the market
- Get a high interest current account - If your current account cash is earning a measly 0.1% then the time to switch is now! The best high interest current accounts offer better returns than most savings accounts
- Shop around - Whatever type of savings account you want, it’s essential that you shop around and compare deals to get the best rate possible
- Renounce loyalty - With rates as they are, it’s crucial that you keep an eye on the interest you are receiving and are not afraid to switch to a better deal. Blind loyalty will lose you money!