Why savings can fall even when the base rate rises

The Bank of England has just increased the base rate to 4%, it’s the tenth rise in a row - representing an incredible 40-fold rise in the cost of borrowing in a little over a year.

It’s also the highest rates have been since the global financial crisis in 2008/2009 - when the Bank’s interest rate setting Monetary Policy Committee slashed rates from 4.5% to 0.5% in six months. 

But while this has been terrible news for people on variable rate mortgages, the news for savers has been less encouraging.

How savings rates have changed

In November 2021, with the Bank of England base rate at 0.1%, the average return on an instant-access savings account was 1.34%.

A year later, after the MPC had raised rates to 3%, the average return on instant access savings was 1.39%. It’s since risen to 2.05%, better, but still only half the current base rate.

The picture was worse on notice accounts. Between November 2021 and today, the average return on notice accounts has risen from 2.66% to 2.94% while the Base rate rose from 0.1% to 4%.

But on fixed-rate savings bonds things have actively become worse in recent months. 

Between December last year and January this year rates on fixed one-year, two-year, three-year and five-year fixed rate bonds actually fell.

How The Bank of England sets rates

The Bank of England sets the UK base rate in an effort to keep price rises elsewhere in the economy under control.

To bring price rises under control, the MPC raises interest rates. The idea behind this is that if savings are more rewarding and borrowing more expensive, people won’t spend as much money.

And if people aren’t spending as much money, that puts pressure on businesses to keep prices down.

The Bank’s target is a 2% rise in consumer prices, compared with the same month last year. Given inflation is currently 10.5%, it’s fair to say whatever it’s done hasn’t been enough.

But the Base Rate set by the MPC only directly applies to what high-street banks pay, not to what they charge the public.

High street banks change interest rates for very different reasons.

How high street banks set interest rates

Banks have to balance the amount of money they have in customer deposits with the amount of money they lend out to people.

It’s actually a legal requirement - to prevent banks lending everything they have on deposit out, leaving nothing left for customers who’d like to withdraw the money they have saved there.

But there’s a consequence to this.

If a bank needs to increase the amount of money they have on deposit, they don’t need to match the Bank of England - they only need to offer more than their rivals to see savers switch to them.

And if a bank doesn’t need any extra cash on deposit, it has no clear financial incentive to raise its savings rates at all.

So, rather than waiting for the Bank of England to raise rates, if you want a better return on your savings what you really need is a price war.