Calls for interest rate freeze
Savers are in real danger of seeing the returns on their nest-eggs drying up altogether if the Bank of England cuts the base rate again this week.
On Thursday, the central bank’s Monetary Policy Committee (MPC) will meet to discuss the outlook for inflation and economic growth, and vote on whether a further base rate cut is warranted. The MPC has cut rates by a total of 3.5% since October; it started by reducing the base rate by 0.5%, before implementing a surprise 1.5% reduction in November.
In December rates were slashed by 1%, but in January a more moderate 0.5% cut was decided upon. The base rate currently stands at 1.5% - its lowest level in the Bank of England’s 300-year history.
Many economists have predicted that the base rate could be reduced further and even potentially fall to zero, as a result of the recession. With inflation falling, the MPC’s focus is likely to continue lowering interest rates to spur economic growth, help businesses and consumers.
However, historically low interest rates have been a major blow to savers and pensioners, and with only a proportion of borrowers benefiting from rate cuts, concern is mounting that rates should not be cut any further.
Adrian Coles, director general of the Building Society Association, points out that interest rates on savings accounts have plummeted in the past few months; interest rates on fixed-rate deals were 7% or more in early autumn, but are now closer to 4%, while average rates on instant access accounts are less than 1%.
This means many people have seen their incomes from savings drop by almost 75%, says Coles.
“The cuts in interest rates have had a severe impact on savers,” he adds. “This drop in income is particularly serious for pensioners who have saved all their lives and now face a sharp reduction in their income and living standards. For pensioners dependent upon interest income from their savings [to supplement their pension], prices would have to fall by an unimaginable 75% for them to maintain their living standards.”
Coles says the MPC must refrain from making further cuts to the base rate until the impact of its previous reductions becomes clearer.
Although inflation is now starting to fall back from its 5.2% peak in September the cost of living is still rising by 3.1% a year - so for many people, energy bills and food costs remain high. British Gas recently cut the cost of its standard tariff by 10%, but so far none of the other five energy giants have unveiled price cuts.
According to moneysupermarket.com, 78% of people have been using their heating less than they would like in order to offset the cost of gas and electricity.
Scott Byrom, utilities manager at moneysupermarket.com, says: “While encouraging, the recent 10% price cut from British Gas is little relief for those struggling to make ends meet. After the unprecedented price hikes to both gas and electricity bills last summer consumers will need to see further reductions before they can afford their bills.”
Pensioners are particularly vulnerable to high energy bills – and they are also being punished by low interest rates. For one, those attempting to earn an income off their nest-eggs are likely to have seen this reduce dramatically.
Even those people who have their savings in a fixed-rate deal are bracing themselves for a payment shock down the line; rates on fixed savings accounts have fallen dramatically since October, with the top deals paying little over 4% and average rates less than 3% AER.
At the same time, interest rate cuts are also hitting people through the state pension system, according to Dr Ros Altmann, former pensions policy adviser and a governor at the London School of Economics. Means testing for pension credit takes into account all of an individual's retirement savings, including pensions as well as ordinary savings accounts.
However, rather than looking at the actual amount people earn on their savings, means testing assumes people earn 10% interest a year.
“This is robbing pensioners of their benefits,” Altmann adds. “Not only do the medium income pensioners lose out because they earn less on their hard-earned savings, but the government is also denying them pension credit because it has refused to recognise that their savings income is cut.”
There is also concern that further interest rate cuts won't help business. According to the Federation of Small Businesses (FSB), interest rates should be frozen this month until there is clear evidence that this monetary policy is having a beneficial impact on the economy.
The FSB's research suggests that many small businesses have not seen any improvement in their ability to access finance despite historically low interest rates. John Wright, national chairman at the FSB, says that access to finance, rather than the cost, remains a key problem for these small firms.
“These figures suggest that the recent interest rate cuts are not having the desired effect and other means of economic stimulus are required," he adds. “The concern now is that if rates are cut any further there may not be too much more room for manoeuvre in the economy.
"The onus is really on the banks to start promoting these lower rates to fire up the economy.”
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.