The banking crash of 2008 created a perfect storm for savers. Record low interest rates – designed to stimulate spending and borrowing – allowed rising inflation to far outstrip the returns achievable by saving alone.
Savers were confronted with three choices: watch their capital depreciate in value, invest in an uncertain stock market or simply spend it. In a recession sparked by unsustainable debt, the financially responsible were made to suffer.
But with inflation finally falling to the Bank of England’s target 2%, a number of products are already beating inflation. Are things – finally – looking up for savers?
After years of inflation holding relatively steady at around 5%, inflation finally fell back to 2% on the CPI measure in December 2013.
This means two things for savers. Firstly that even with historically low interest rates, there will be more inflation beating savings products available. Secondly, as wages start to rise again, there will theoretically be more money left over at the end of the month that can be saved.
Ultimately this means a return – albeit a slow one – to saving being a profitable pursuit, rather than a ‘least worst’ option.
Lower inflation means more than just low interest rates finally winning out. Low inflation has a reciprocal relationship with wider economic confidence. Aside from rising wages, this will also feed into banking activity.
It’s difficult to imagine now, but there was a time – not so long ago – when banks used to compete on who could offer the best interest rate on savings. As the recovery takes hold and banks become more confident, we will eventually see a return to a competitive savings market.
This won’t send rates shooting back up to the heady heights of 5% any time soon, but even decimal increases make a difference.
Until then, savers with a bigger appetite for risk can cash in on the increasingly confident recovery by taking advantage of the buoyant stock market. The FTSE 100 recently celebrated its biggest annual climb since hitting an all-time low in 2009, ending 2013 at 6749.1 points – 14% up from the end of 2012.
While interest rates remain low, investing is easily the most viable option for beating inflation by anything more than whisker – try comparing what you can get with Fidelity’s Stocks & Shares ISA calculator and ISAs.com’s Cash ISA calculator. Although it goes without saying that stocks can go down as well as up.
Base rate rise?
Of course, the biggest boon for savers will be when the base rate is finally pulled up from its historic low of 0.5%, raising interest rates across the board – bad news for anyone servicing variable rate debt – but a long overdue windfall for those with capital and little appetite for investment.
When Mark Carney took over as governor of the Bank of England he issued ‘forward guidance’ that he would consider raising the base rate once unemployment fell to 7% – it was a move designed to signal to an anxious business community that a rate rise would not come soon, and when it did, only when the economy was decidedly on the mend.
With unemployment having already fallen to 7.1% in the three months to November 2013, Carney has been forced to offer repeated assurances that the base rate isn’t coming up any time soon. The soonest a base rate rise is reasonably expected is the second quarter of 2015, with cynics predicting a post-election (May) bump.
It may not be coming for at least another year, but the take-home for savers is this: a base rate rise is coming.
The fixed rate question
All the above raises the question: what to do about fixed rates?
Relatively lengthy commitments of 3-5 years for fixed-rate ISAs and savings bonds have long been the only way to get anything approaching a decent rate. But with confidence rising, an impending base rate increase and lower – and therefore easier to beat – inflation, making such a commitment now would seem an unwise move. But to avoid fixed rates altogether would be to confine yourself to the lowest of low rates, in all likelihood continuing to depreciate the value of your capital.
Predicting the future may be foolish, but a certain amount of crystal ball gazing is necessary in financial planning. The only reason to avoid medium to long term fixed rates now is because rates are set to rise within the period you’d be committing to. But let’s look at that a bit more closely.
Let’s assume the base rate is going to go up in May 2015. If you take out a 3 year fixed saving bond now, that would be around a third of the way through the period. The truth is that as the economy is still fragile – and will be for quite some time – the rate rise is likely to damage confidence more than bolster it at first. There will be a period of adjustment, which will eat into the interest rates banks are willing to offer. And the rate rise will likely be small – quarter of a percent, half a percent – not exactly an interest bonanza.
Realistically, rates won’t return to ‘normal’ for quite a while. As ever, the best approach is likely a mix of fixed and variable rates, savings and investments. Missing out on an interest bump may be a risk you have to take to avoid depreciation. It all depends on your personal circumstances.
In short? Things are looking up for savers. But there might be a bit of neck ache along the way.