Inflation is at 3pc and Bank Rate is set to rise: this is what savers need to do right now

Richard Evans
The increased competition in the savings market has been pushing rates up quickly over the past year - Alamy

Prices have risen by 3pc on average over the past year, according to figures released this week, and savers will be acutely aware that interest rates on their deposits are failing to keep pace.

However, the Bank of England has hinted that the next rise in official interest rates is imminent. How can savers best navigate these shifting movements?

How high will inflation go?

This year’s spike in the cost of living has largely been caused by the fall in the pound that followed the EU referendum. This made imports such as food and energy more expensive.

However, it was a “one-off” event, so its effects will begin to drop out of the annual inflation figures soon. The consumer prices index will peak at about 3.2pc this month, according to Capital Economics, a respected consultancy, and fall back below 3pc by the end of the year.

What will happen to Bank Rate and savings rates?

The Governor of the Bank of England has hinted that Bank Rate could rise next month and many in the City are betting on a rise this year. An increase can be expected to boost sterling and thus relieve the pressure on inflation. 

The mere suggestion of a rise has caused the value of the pound to rise, although many expect the Bank to follow through with an actual increase to avoid undermining its credibility. But savers should not expect an automatic improvement in the interest rates they receive.

Best cash Isas now paying 76pc more than at start of 2017

“It’s been a decade since the last rise in Bank Rate and the savings market has changed dramatically since then,” said Anna Bowes of SavingsChampion, which offers a savings management service. “Banks and building societies have been competing for business much more strongly this year and this will drive best-buy rates far more than any move from the Bank of England.”

Which savings accounts should I choose?

The best rates of all are offered on high-interest current accounts, such as Nationwide’s, which pays 5pc, while Tesco and TSB pay 3pc*. These rates apply only to small balances and there are other conditions, but it makes sense to use these accounts for the first slice of your savings. 

The increased competition in the savings market has been pushing rates up quickly over the past year – for example, the interest you will earn on a given sum in a best-buy easy-access account is 30pc higher than a year ago, while the improvement in one-year fixed returns is 32pc, SavingsChampion said. If that trend continues, locking your money up for many years is likely to prove a bad idea. 

Another reason to shy away from the longest-term bonds is that the incremental improvements diminish. The best instant-access bond, from Bank of Cyprus UK, pays 1.28pc, while locking in for one year improves the rate by 0.57 percentage points to 1.85pc (from Access Bank).

Savings accounts: Find the best savings rates

The best two-year bond (from Atom Bank) pays 2.05pc, a rise of 0.2 points for an extra year on the term. But tying up your money for a further three years in the best-buy five-year bond (2.45pc from Paragon Bank) will yield only a further 0.4 percentage points.

Ms Bowes recommended holding a “portfolio” of bonds of various types. When your one-year bond matures, for example, you could reinvest that money at a better rate if rates have gone up. Fixed-rate Isas pay less than equivalent bonds.

Compare current accounts in one go with The Telegraph Money Comparison Service

A return to ‘hyperinflation’ further into the future?

Many readers will remember the 24pc inflation Britain experienced in the mid-Seventies and wonder whether such rates could be seen again.

“External risks are unavoidable,” said Howard Archer of the EY Item Club, an economic forecaster. “Sterling could take another tumble or the price of oil or other commodities could shoot up.” Some professional investors are also worried.

The managers of the Ruffer Investment Company, a highly risk-averse portfolio, have large holdings of index-linked government bonds to protect against high inflation.

“We see inflation on a rising path, with any interest rate rises both ‘behind the curve’ and eventually capped by what an indebted economy, addicted to low rates, can bear. At that point it will be clear that there is no brake on inflation,” they told investors this month.

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