Savings choices at a time of high inflation

“The shortest period of time lies between the minute you put some money away for a rainy day and the unexpected arrival of rain,” the US financial columnist Jane Bryant Quinn wrote.

Many UK savers have spent the past two years becoming more familiar with this sentiment, as they squirrelled away record amounts of cash during the Covid-19 crisis only to find themselves in urgent need of funds as the economic clouds darkened.

During lockdown, we turned into a nation of savers. Unable to spend on holidays, socialising and commuting, “forced saving” combined with “fear saving” — prompted by worries about the economic outlook — to boost deposits.

Those fears have now been realised in a severe cost of living crisis, with inflation reaching a 40-year high. At the same time, the cash savings market has sprung back into life after years in the doldrums, when savers saw paltry returns on their “rainy day” money.

Deposit account interest returns have increased sharply as savings account providers have responded to five consecutive rises in the Bank of England’s base rate, sharpening the appeal of saving even as prices for goods and services grow at a faster rate.

Deciding how much to save, and where best to place it, are questions that concern not only those with a little spare cash, but also mainstream investors, aspiring property buyers, pensioners and retirement savers.

Those with funds in the stock market are typically advised to hold a portion in cash. Financial advisers recommend a reserve of between three to six months of income as a bulwark against a collapse in equity prices, loss of employment or other unexpected financial setbacks. But cash earmarked for investments can also be used to seize stock market bargains.

It may still be eroded by inflation — indeed with UK consumer prices rising 9.4 per cent in July it almost certainly will be. But for those needing to hold cash — and that means nearly all of us — finding ways to lose it less rapidly is a worthwhile goal.

With the reinvigoration of the savings market come new questions and challenges for those looking to make their cash work harder. But for the first time in over a decade, taking the trouble to get it right can deliver a tangible reward.

What returns can you expect?

Twelve months ago, the highest-paying easy access savings account gave you 0.5 per cent annually on your money. Today, that rate has more than tripled to 1.52 per cent. For someone with a £20,000 balance, that means their annual return jumps from £100 to £304.

If you are comfortable giving 90 days’ notice to access your savings, Investec has just launched a table-topping account paying 2.1 per cent. The equivalent best buy last July paid 0.85 per cent, further evidence that all sectors of the savings market are booming.

The returns on fixed-rate savings — where money is locked away for a set period — have risen sharply too. In June 2021 the best one-year fix paid 1.1 per cent. A year on, the top rate is 2.75 per cent.

Rewards for a two-year fix are higher still, with the best buy from Gatehouse Bank at 3.1 per cent giving a 24-month interest return of £1,550 on £25,000.

Setting aside Premium Savings Bonds (see below), products from the state-backed National Savings & Investments — historically an attractive option for those with substantial cash savings — fall well short of rivals in terms of rates, despite some recent improvements.

However, existing NS&I customers will be less likely to switch away now that interest rates on Guaranteed Growth Bonds and Income Bonds have been significantly improved.

NS&I’s Green Savings Bonds have raised a disappointing £288mn to date — an unsurprising performance considering the 1.3 per cent rate requires depositors to lock away their cash for three years. While your savings will help “contribute towards green projects”, it is at the cost of a very uncompetitive return.

Looking at the wider savings market, a dozen or more three-year fixed rate bonds pay 3 per cent or more. Aldermore offers a rate of 3.15 per cent and the benefit of monthly income. On a £50,000 savings pot, that amounts to £1,575 interest income a year, compared with just £650 with the NS&I Green Savings Bonds.

Fixed-rate bonds confront savers with a trade-off, the cost of higher returns being reduced access to funds. Those looking for a true “rainy-day” fund may need to accept a lower rate to ensure they can get at their money quickly if needed.

For many, the best solution is a mix of savings accounts, giving instant access to a portion of their cash and a higher rate on money that’s not required for a year or two — perhaps set aside for a specific purchase such as a house deposit.

Should I lock into a fixed rate now or wait a little longer?

The Bank of England’s next decision on setting its main interest rate is due on August 4.

With inflation still rising, the market is predicting further increases during the second half of the year. So should you plump for a best buy fixed rate now or sit tight in the hope of a higher rate in future?

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, says more rate rises are on the cards, but waiting for a better rate before opening a fixed rate account can lead to problems.

“We’re tending to see rates creep up one by one as each bank moves for its own reasons. It means whenever you fix, there’s a reasonable chance that something will come along tomorrow that’s more generous.

“If you decide to wait for the top of the market, you don’t know how long you will be waiting, and you won’t know you’ve reached the top until it passes. It means you may not get the best possible rate,” she says.

Splitting cash between a higher paying account and an easy access account is one option, says Anna Bowes, co-founder of Savings Champion, with the latter allowing savers “to take advantage of the opportunity of higher rates if they come along”.

The best buy table below shows the additional reward for locking in for two years compared with the one-year fix. However, additional interest to lock in at three years and above looks less appealing.

A savings account or a cash Isa?

Adults put about £75bn into Isas in 2019-20, according to figures from HM Revenue & Customs. Of that, nearly £50bn went into cash Isas.

These savings vehicles remain popular, but their tax-related benefits have been winnowed away in recent years.

Bowes says a big change came in April 2016, when the personal savings allowance (PSA) was introduced. Under the PSA, she says, “basic rate taxpayers pay no tax on the first £1,000 of interest earned each year, while for higher rate taxpayers they have a £500 allowance”. 

To put this into perspective, basic rate taxpayers in the current best 1-year fixed rate bond with Close Brothers, which pays 2.75 per cent, will reach the PSA limit only when they have accumulated a deposit of £36,375. For higher rate taxpayers it is £18,188.

Cash Isa products have also suffered latterly from a lack of competitiveness among providers. The interest rates they offer are well below those offered on the equivalent standard savings accounts.

The same could be said of easy access savings accounts offered by the big banks, where savings rates have barely moved despite a 1.15 percentage point rise in the BoE’s base rate.

The best easy access accounts pay 1.52 per cent, while the returns from those at the big banks are derisory. Barclays, for instance, offers a 0.01 per cent easy access savings rate; Lloyds Bank and HSBC 0.2 per cent; with NatWest and Santander both offering 0.1 per cent (see below). 

Having enjoyed ultra-low costs of funding in recent years, banks awash with cash have little incentive to attract new depositors by sharpening their rates.

What next for savers?

During the Covid crisis, UK households were salting away an additional £15bn-£20bn a month with banks and building societies.

The latest Bank of England statistics show a very different picture. In February and March there were net surpluses of just £4.1bn and £4.6bn respectively, as the nation dipped into its savings pots.

The Bank of England says it will continue to bear down on inflation but it admits it could be two years or longer before it gets close to its 2 per cent target. With a further four opportunities for the BoE to raise rates this year, savers can expect better deals ahead — but must carefully weigh the costs of holding out against the likely gains from higher savings rates.

Unfamiliar with best-buy savings providers? Don’t be deterred from switching

Some people keep their savings balances with high street banks despite being paid some of the lowest savings interest rates in the market.

They claim not to have the time or inclination to transfer their money to a new more rewarding provider, while others have concerns regarding the safety of their cash.

First, savers should know they can open a new account within a matter of minutes online. And as for the safety issue, nearly all of the names topping the “best buy” tables are covered by the same Financial Services Compensation Scheme (FSCS) protection as the big high street banks.

James Blower, founder of The Savings Guru, says: “Following the global financial crisis in 2008, banks are much better regulated in the UK and there have been 37 new banking licences issued.

“The process of being awarded one typically takes at least three years as the regulators want to make sure that new banks are financially sound and well run.”

These new “challenger” brands operate a specialist banking model that enables them to offer competitive rates. They tend to focus on specific sectors including business finance and commercial lending where interest margins are wider, allowing them to pay better returns to attract retail deposits.

The new banks are leaner, too, with much of their business managed online and no costly overheads from branch networks.

Remaining loyal to your bank isn’t the smartest move you’ll make and the numbers back this up. An easy access savings account with Barclays pays just 0.01 per cent, so on a £25,000 savings balance your loyalty will be rewarded with a mere £2.50 per year.

Compare that with a best buy 1.52 per cent from Shawbrook Bank and the same £25,000 balance would earn you £380.

It’s a similar story with fixed rate savings, with HSBC paying just 0.55 per cent for a one-year fixed rate bond compared with the current best buy from Close Brothers (FSCS protected) at 2.75 per cent.

Stick with HSBC and you’ll earn £275 in 12 months on £50,000, or take a few minutes to switch to the 2.61 per cent best buy and you’ll pocket £1,375 for the same product and no additional risk.

These numbers are conclusive. So what’s stopping you from finding a better home for your savings pot?

Andrew Hagger is a personal finance expert and founder of consumer website MoneyComms.co.uk