Cash has made a comeback this year as interest rates on savings accounts soar to their highest level in more than a decade.
The average easy-access account now pays 1.43 per cent, up from 0.19 per cent a year ago, according to the data company Moneyfacts – the highest rate in more than 13 years. The average one-year fixed deal pays 3.51 per cent, up from 0.8 per cent last year and the highest rate since 2009.
At the same time, stock markets have been volatile. The S&P 500, the main US stock market, fell by nearly 20 per cent in 2022, while the UK’s main market, the FTSE 100, has remained flat.
As a result, savings deals are turning heads. The best rates are often offered by building societies and, according to the Building Societies Association, their savings balances increased by £8.4bn this summer, double the £4.2bn that was saved in the same period in 2021.
Rates have headed skyward because the Bank of England, the UK’s central bank, has increased its base rate from 0.1 per cent last December to 3.5 per cent in an attempt to curb inflation. Inflation was 10.7 per cent in the year to November, the highest rate since the early 1980s.
The rate set by the Bank trickles through to the rates charged on loans and mortgages and offered on savings accounts. The idea is that high rates will encourage people to save more and borrow less, and if people spend less, prices won’t rise as quickly.
Where is best? Despite rising rates, you still need to be picky about where you stash away your cash as some banks and building societies are quicker to pass on rate rises than others.
The top paying easy-access account, where you can take your money out if you need to, comes from the online bank Zopa at 2.89 per cent, according to the website Savings Champion. If you put £1,000 away, you would earn almost £29 in one year.
You can get a better rate if you lock your cash away for longer — but only do this if you are sure that you will not need the money. The best one-year deal comes from Cahoot, a digital bank part of Santander. It pays 4.25 per cent, meaning you would get £42.50 on £1,000 saved for one year.
You usually get an increasingly higher rate the longer the fix, but what you get also depends on the outlook for rates. At the moment, banks think rates will fall in the long-term, so the difference between a two-year and five-year deal is quite narrow.
The best two-year fixed deal from DF Capital, a smaller bank based in Manchester, pays 4.6 per cent, so you could get £46 on £1,000 saved for a year, or £92 for the two years. If you lock your cash away for five years, you could get 4.8 per cent from Nottingham Building Society, or £48 over one year.
Rates have started to come down, so it’s worth locking in now if you are yet to do so. Sarah Coles, from the investment platform Hargreaves Lansdown, said: “If you’ve been waiting for the right time to fix, you don’t want to wait too long. We may even be past the peak already.”
‘The high street banks offer terrible rates’
After six years of putting up with rock-bottom interest rates from her high street bank, Lucy Gordon decided to take some action with her savings.
She had about £25,000 in a savings account with Lloyds Bank — but she was only earning 0.1 per cent interest, or £25, a year. It had been even less before rates started to rise this year.
“I’ve banked with Lloyds for 20 years but the rates they offer are awful,” said Gordon, 34, from London. “When interest rates were low it didn’t bother me so much, but when rates started to increase this year I decided to search around.”
Lucy Gordon decided to move banks to benefit from better rates (Natalia Ruszczu)
Gordon, who runs a financial modelling consultancy called Farley Cove, opted for Zopa, an online bank where you can earn more on different “pots” if you lock it away for longer.
She earns 2.86 per cent on the money she can access immediately, which is for emergencies. She then has three savings pots: one for the tax she will owe at the end of the tax year, one for a holiday in 2023 and one for a holiday in 2024. This money is locked away for 95 days, so Zopa pays a higher rate of 3.26 per cent.
“I did some research on the best rates. I ended up looking at Zopa as it was near the top, and then the app and usability of it made me ultimately go for it,” said Gordon. “High street banks are happy to charge a fortune the moment you go 1p into your overdraft, but they don’t offer the equivalent reward for you keeping your accounts well-stocked.”
Things to think about
One downside of higher savings rates is that some savers will need to start thinking about whether they owe tax on the interest they have made. This only applies to savings held outside of an Isa – anything within an Isa wrapper is tax-free.
If you are a basic-rate taxpayer, you can earn £1,000 in interest before you have to pay tax on it, called your personal savings allowance. If you are a higher-rate taxpayer, you can earn £500 and if you pay top-rate tax, you lose your allowance completely.
You should also remember that while savings rates are high, inflation is higher. This means that it is likely that your money is still losing value in real terms.
Inflation is expected to be about 5 per cent by the end of next year, which means that your savings will be worth less in real terms in a years’ time unless you were able to secure a rate of 5 per cent or above today.
For example, if you put £5,000 in the best paying one-year fixed account at 4.25 per cent, you would earn £212.50 in interest, leaving you with £5,212.50 in a years’ time. However, if inflation was 5 per cent over that year, you would have about £4,970 in real terms, even after interest.
But savings accounts are likely to be more fruitful in real terms going forward. The Bank of England forecasts that inflation will drop sharply by mid-next year, and will then fall below the Bank’s 2 per cent target in the following years.
As longer-term fixes today are offering more than 4.5 per cent, you could be earning this each year as inflation falls below 2 per cent – and your money will be worth more in real terms.
Coles said: “Inflation looks backwards, while savings rates look forward and are fixed for the future. It means you don’t need a savings rate of 10.7 per cent to beat inflation in the year to come.”
