How inflation is killing your cash savings

Inflation is rising in the UK, and that is a big problem for many savers because interest rates remain very low. For many savers, this means that their cash deposits are losing value over time.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
How inflation is killing your cash savings

Inflation is one of the most reliable measures of household wealth and economic growth. In short, when inflation goes down, your money is worth more than it was before; when it goes up, your money is worth less. And inflation in the UK is on the rise once more. 

You will notice this in a number of ways — higher inflation may mean that the cost of petrol goes up by a penny or two, adding up to several pounds over the course of the month; your monthly grocery bill may be £400 one month and £410 the next, for the exact same items. Likewise, when inflation goes down your spending power goes up.

The same logic applies to your savings. As inflation rises, it lowers the value of your saved money, eroding away any value you are getting from interest-only accounts, including cash ISAs. You may think you are getting a steady 1% or 2% in interest by leaving your money in accounts like these, but if you want to work out your ‘actual’ interest rate, you have to deduct the current rate of inflation, plus any fees you are paying on the account. Whatever is left over is your real interest, or free money. 

For instance, if you are keeping your money in a fee-free savings account which pays 3% interest, simply take away the 0.9% which has been lost to inflation, and you are left with 2.1% in real interest. That would turn £1,000 of savings into £1,021 at the end of year one — not a bad return for simply leaving your money in a bank account.

There’s a catch, however –— not one single UK-based savings account is currently offering 3% interest, or anywhere close to that. And while the rate of inflation is on the rise once more, the most recent interest rate move by the Bank of England was down to just 0.25%. 

In fact, according to recent data from Moneyfacts, in November the average easy-access cash ISA rate was just 0.73%, down from 1.09% a year earlier. Furthermore, barely any cash ISA accounts are able to offer more than 1% in interest, and many accounts have reduced their rates as low as zero. This has prompted the Financial Conduct Authority (FCA) to step in and warn savers that they could actually be losing money by leaving it in a high street savings account, encouraging them to make a change if they are not getting value for their money. 

'In a well-functioning market, providers should be competing to offer the best possible deal to consumers,' said Christopher Woolard, executive director of strategy and competition at the FCA. 'Our data shows that some consumers could be better off by opening a different account. One of our regulatory priorities is the treatment of long-standing customers and we want to see all customers benefit from competition and innovation in financial markets.'

Banks have little incentive to match their interest rates to inflation at the moment, as they are struggling to make money when the Bank of England’s base rate sits at a record low of 0.25%. This means that savers can expect a little bit more pain in the years ahead. If bank rates stay the same, and inflation rises to 2.7%, then the average saver would actually be paying a surcharge of almost 2% on the standard 0.73% cash ISA rate. 

This is not unheard of. In Japan and in parts of Europe consumers are already struggling with negative interest rates, and the European Central Bank has openly admitted that it hopes the low and negative bank rates will encourage consumers to diversify away from cash savings, while stimulating the lending markets.

With this in mind, it’s no surprise that so many savers are now considering investing instead. Once considered relatively risky, stocks and shares ISAs are becoming more and more attractive to savvy consumers who can’t afford to let their savings waste away. 

The impending inflation crisis means that there has never been a better time to reassess your savings and consider all your options. The financial landscape is changing, and no one can afford to simply take their savings for granted. 

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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