Savers: make the most of low inflation
The cost of living is at its lowest level for several years, giving respite to savers who have felt the pinch from interest rate cuts.
The latest inflation figure is due out next week, and while there is still a question mark over whether the Consumer Prices Index (CPI) – the official cost of living – will have risen or fallen, the Bank of England has suggested it will remain low for some time.
Indeed, Mervyn King, governor of the central bank, said in the most recent inflation report that he expects inflation to fall below 1% in the future. The CPI hit 1.8% in June, the first time it has fallen below target since 2007.
Not everyone is convinced that low inflation is here to stay; the Bank of England’s quantitative easing measures (which have seen it pump £175 billion of new money into the economy) pose the risk of rocketing inflation in the years ahead. And when the rate of VAT returns to 17% at the start of 2010, the cost of living is expected to spike.
However, Charles Davis, economist at the Centre for Economic and Business Research says: "Even assuming the base rate remains at 0.5% until the end of 2011, the Bank of England expects inflation to undershoot the target rate until the final quarter of 2011."
So, what does this environment of low inflation mean for savers? For one thing, it suggests that the Bank of England base rate – that is, the official rate of interest – will remain low for some time.
Vicky Redwood, UK economist at Capital Economics, explains: “Even if quantitative easing is not extended any further, the clear message from the inflation report was that a policy tightening is a long way off. We continue to expect monetary policy to remain extremely loose for the rest of this year and next year too.”
The base rate is currently just 0.5%, having been cut dramatically at the end of last year and during the first months of 2009. On the face of it, this is bad news for savers as savings accounts have had their headline rates chopped dramatically in response.
However, Kevin Mountford, head of banking at moneysupermarket.com, says things are not as bleak for savers as they may think.
For a start, although the base rate is currently just 0.5%, the average fixed-rate account paid 3.03% in July - that’s 2.53% above base. In comparison, the average fixed-rate account paid 6.06% in July last year, which was just 1% above base. The previous July, both the base rate and the average fixed rate were 5.75%.
The gap between base rate and savings rates can be seen in the instant access market too. While the average account is currently dire, at just 0.15%, the best-paying deal - Coventry Building Society’s postal account, which pays 3.3% AER – is 2.8% above base.
In addition, low inflation is good news for savers, as it technically means your money goes further, although the benefits of this might be wiped out by the impact of the credit crunch and recession on your finances.
When it comes to making the most of low inflation and beat dismal savings returns, it’s vital you consider the best rates on the market rather than put up with your current deal. However, rate is not everything, and savers should be careful to look at the features of savings accounts to make sure they are suitable for them.
"Many of the highest easy access rates include introductory bonuses, usually for 12 months, and some also restrict withdrawals,” warns Mountford. “This doesn't mean you should steer clear of such deals - just make sure you adhere to the terms and conditions and in the case of bonuses, move your money once the introductory offer ends. "
GREAT FIXED-RATE DEALS
|West Bromwich BS||5.45%||-||4.75%||4.45%||-|
THE BEST EASY ACCESS DEALS
* Rate includes 1.3% bonus
* Only four withdrawals a year
|Egg||3.25%||* Rate includes 2% bonus|
|Alliance & Leicester||3.15%||* Rate includes 1.65% bonus|
* Rate includes 2.65% bonus
* Access is via telephone only
|ING Direct||3%||* Rate falls to 0.5%|
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
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).
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.
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.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
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