Savings account Guides

Why are savings interest rates so low and when will they go up?

Writes Hazel Cottrell hazel.cottrell@consumerchoices.co.uk

Savers are suffering with pitiful interest rates at the moment. We look at why this is and when things might improve… (Updated 18/2/10)

Savers are having a rough time of it at the moment, with savings interest rates lingering at pitifully low levels.

The average interest rate on easy access savings accounts was at 0.76% as of 18 February 2010, according to financial information company Moneyfacts (www.moneyfacts.co.uk).

But when will interest rates start to rise again? In this guide we will answer this question and showing you what to do now to get the most from your savings.

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• Why have savings rates been cut?
• When will they go up?
• Top tips for getting the best return on your savings

Why were savings rates cut?

Savings rates have basically been cut because the Bank of England base rate was cut to its lowest ever level. But why must savings rates follow the base rate? Here 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 which 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 that 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 given to savers are falling.

This explanation should ring true for building societies, and while there are additional complicating factors when it comes to banks (like toxic debts), the principle remains the same.

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When will they 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. Most analysts think the base rate will remain between 0%-1% well into 2010 and perhaps even in 2011, so the light at the end of the tunnel remains to be seen.

However, while the average rates on savings accounts are fairly low, there are some gems amongst the pebbles and if you do have savings, finding the best paying account should be top of your list of things to do.

Indeed, while the base rate has been at its historically low level for the last six months, in the past month more attractive deals have appeared on the market.

Over the last year savings rates first dropped right down with the base rate, but they did start to pick up as providers realised to raise funds to lend their savings accounts needed to be more attractive.

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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!

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