Why Have Interest Rates On Savings Not Gone Up Yet?
Just over 3 weeks ago The Bank of England increased its base rate from 0.25% to 0.5%. Two commonly asked questions are "when will savings rates increase" and "what does the rate increase mean for me"?
To unpick the above questions, lets start with how banks make money...
...in very simplistic terms, banks lend money and charge interest; this interest is their income. For example, a bank will give Bob a mortgage of £100,000 with a 3% interest rate per year. In that first year the bank will make £3,000 pounds of income from Bob.
The bank needs that original £100,000 to lend to Bob. One of the ways it does that is by providing a deposit or savings accounts to people who want to save money. The bank offers a 2% interest rate on their savings accounts. Lynsey gives the bank £100,000 into a savings account. The bank pays £2,000 pounds of interest in the first year. The bank has £100,000 to pass onto Bob; the bank receives £3,000 interest from Bob, and I pay £2,000 pounds to Lynsey. I, therefore, make a profit of £1,000 pounds per year.
Where does the Bank of England come in?
When the economy slows like it did in 2009, everyone gets a bit nervous. People stop spending money; this is bad for businesses who sell less and make less money. If the businesses have less money, they can't afford to pay wages. If they cannot pay wages, they have to make people redundant. Unemployment to go up. Now more people have less money to spend, so businesses sell even less and make less money and they have to let more people go. You can see where this is going...a bad downward spiral.
Bank of England Role
The Bank of England steps in and says it will lend banks such as Nationwide, Barclays, HSBC, Natwest etc money at a very low interest rate (known as the base rate). These banks can therefore continue to lend people money. The Bank of England gets its money through quantitative easing; it prints more money. Lending money to individuals means they have money to spend, which in turn keeps businesses going and keeps unemployment rates low. So, the bank would get that £100k from the Bank of England at an interest rate of 0.25%; this means the bank can lend Bob £100,000 at 1% interest. Bob only has to pay the bank £1,000 interest, versus the earlier £3,000 interest, and the bank only has to pay £250 to the Bank of England. Therefore, the bank still makes a profit and everyone keeps spending. Great stuff.
Increasing the Rate
The bank of England has increased interest rates from 0.25% to 0.5%. What does this mean for you?
If we look at Bob, who borrowed money. If Bob has a mortgage, it will either be a fixed term mortgage, or a floating term mortgage. If it is a fixed term mortgage, then good news for Bob; his monthly repayment won't increase until the term of his mortgage is up. I.e if Bob has a fixed term mortgage of 3 years which started in 2015, his monthly repayments will be the same until 2018.
If Bob, however, has a floating rate mortgage, the monthly repayments he makes will increase in line with the movement in the Bank of England interest rate.
If Bob has loans, credit cards, soft furnishings on credit, the repayments will most likely increase as well. If I was Bob, I would try and pay down as much debt as possible. That way you will pay less interest over to a bank.
If we look at Lynsey, a saver. Obviously if borrowing interest rates increase, we should expect saving rates should also increase. NO...there tends to be a lag between borrowing rates increasing and savings rates increases. Additionally, (and this is mer personal opinion!) due to the quantitative easing, a lot of banks are very liquid (i.e they have a lot of money to lend to the Bob's out there) and don't require the savings deposits. This means that they aren't competitive to increase rates.
If I was Lynsey I wouldn't anticipate seeing any increases in savings rates in the short term.
If you have debt, pay it down (mortgage etc). If you have savings, look for other places to position your money; bank savings are low, bonds tend to be poorer in the face of rising interest rates, the stock market is high at the moment, and the property market in London is over-inflated. Being a saver at the moment is hard. Make sure you have used up your pension tax allowances each year. Additionally, alternative lending providers such as Zopa, Funding Circle, Property Partner, still pay good levels of interest on accounts. I'll cover that in a future blog.
My moto, whatever the economic situation, I keep a diversified portfolio of assets between pensions, bonds, property, cash, stocks and shares.
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