Savers have been enjoying a period of good returns on their cash. With interest rates on offer of over 5% for much of the past year it’s been possible to outpace more recent rises in the cost of living. The Consumer Price Index (CPI) measure of inflation fell to 2% in May and June 2024, so there has been the opportunity to grow money in ‘real’ terms.
However, the Bank of England cut interest rates in August from 5.25% to 5%, and this has already impacted savings rates. Further cuts are expected as inflation comes under closer control, but when and to what extent is uncertain. It hinges on inflation and other economic data as it emerges over the coming months.
How do UK interest rates work?
The Bank of England (BoE) Monetary Policy Committee (MPC) meets regularly to set the ‘base rate’, a mechanism which influences interest rates on borrowing and savings. The BoE has a mandate to set the rate at an appropriate level to ensure inflation is at, or close to, 2%. This target is thought to represent a happy medium of encouraging growth without risking instability.
For more than 18 months from December 2021, the BoE increased interest rates aggressively in a bid to counter a post-Covid inflation surge. Now that inflation has receded it faces a different battle: To keep inflation sustainably below 2% despite some upward pressures.
Ominously, inflation rose back to 2.2% in July, which casts doubt on expectations of a steep path of interest rate cuts. To be fair, re-acceleration was widely expected for technical reasons. The negative effect of the energy price cap reduction in July 2023 fell out of the calculation window and no longer suppresses the 12-month figure. However, the upward blip was still a bit more than many economists expected and reflects an underlying stubbornness in services inflation. This is primarily driven by rising wages, which the Bank of England (BoE) is keeping a careful eye on.
When will interest rates be cut further?
Price rises previously returning to target offered a window of opportunity for the BoE to cut rates in the summer. A slim majority of MPC members opted for a 0.25% cut on 1st August, taking rates to the current 5%. However, the Bank will only be able to cut interest rates further if there isn’t a sustained rebound in price rises. In the upcoming meeting on 19th September it is likely to hold as it awaits more data.
After that, at the next interest rate meeting on 7th November, a further cut is on the table. However, it will depend very much on the inflation and other data that comes in between now and then. Wage rises will be keenly monitored as they help determine consumer spending power and costs in the service sector. The latest figure of a 4% increase in pay is a considerable moderation from the 8.3% peak a year ago. But this extra household spending power is still rather too high to be consistent with an inflation rate of 2% going forward.
Overall, it’s likely the Bank will gain more comfort around the downward trajectory of wage rises and receding inflationary pressures in the coming months. As the picture evolves, we will likely see a shallow trajectory of cuts, at a roughly quarterly pace, towards the 4% level by the end of 2025.
There could be a faster cutting cycle if growth disappoints, or inflation remains very firmly subdued. But either way it’s likely that that today’s best cash rates will erode a little further, perhaps presenting a short-term opportunity to lock into higher interest rate fixes at this juncture.
What does it mean for savings rates?
There’s still a positive environment for savers, at least in the short term. Inflation-beating returns from cash are possible as price rises maintain a subdued path and interest rates remain fairly elevated. It’s a case of making hay while the sun shines, though. While we aren’t going to see interest rates returning to anywhere near zero anytime soon, as the market prices in the approach of further cuts cash returns are likely to continue to fall away.
Reductions have already started happening of the course of the past six months. In some cases these have been aggressive with certain high street banks slashing their previously attractive rates. Fortunately, there are still some good, competitive rates available, but it does mean shopping around. A cash platform such as Charles Stanley Direct Cash Savings could assist you in getting a competitive deal. For instance, the best available easy access rate at the time of writing is 4.67% AER.
If you are considering a fixed rate, which involves locking your savings away for a set period, then it might pay to act sooner rather than later. There are still options around the 4.8% mark for a one-year product, and if interest rates are cut a few times that could look attractive versus where they end up in six- or twelve-months’ time. Nothing is certain but on balance it seems unlikely you’ll get a better rate by waiting.
What about tax on savings interest?
Interest on savings, outside of ISAs and over and above certain limits, is taxable. With interest rates having moved higher over the past few years more savers being caught in the tax net.
Your tax rate on savings interest depends on how much earned income or other non-savings income you have. There’s also a tax-free allowance for savings interest, the personal savings allowance, which means some people don’t pay tax on a limited amount of interest:
- Basic rate taxpayers can earn £1,000 of interest in the 2024/25 tax year before paying tax
- Higher rate taxpayers have a lower allowance of £500
- Additional rate taxpayers don’t receive a personal savings allowance
It’s also possible to maximise your untaxed interest in savings and investments by using ISA allowances. Plus, if you are a couple, you can maximise use of yours and your partner’s personal savings allowance and, if applicable, income tax personal allowances too.
Find out more: Tax on savings explained - how much will you pay?
A smart way to bag competitive savings deals
Moving your cash around different banks and building societies to get better rates can be a pain, but there is another way. A cash savings platform offers a range of cash saving accounts with different interest rates from a variety of providers all in one place.
- Manage your savings in ‘marketplace’, moving between accounts with ease. However, if you place money in a fixed term account you won’t be able to switch provider until the term ends.
- Mix and match a range of terms from instant access to five years through one secure account
- A single application, identification check and log in
- A selection of top tier interest rates available from high street and challenger banks
- Minimums starting from just £1
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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