Why savings rates may soon return to rates above inflation

Read Pete’s blog post on Save our Savers on the impact of the ending of the Funding for Lending Scheme. (Original text repeated in full below).

saveoursavers 28 Nov 13

The best bit of news for the UK since the Olympics

The end of Funding for Lending heralds higher savings rates

The announcement this morning by Bank of England to end the Funding for Lending scheme early for mortgage lending is the first bit of good news for savers in over a year. It heralds the possibility of a return to higher savings rates and ones that might approach that of the level of inflation.

In the weeks building up to the Olympics in July 2012, the government announced a scheme that was to inflict misery on millions of UK savers. Brought out in the wake of the euro crisis, it was a desperate attempt to stimulate bank lending and kick start the economy by helping to revive the housing market. To some extent, it has been very successful in its primary objective – in fact so successful that there is talk of the housing market overheating in some parts of the country. This was the reason for its premature withdrawal by Mark Carney today.

But the UK’s savers are still living with the effects of the ‘law of unintended consequences’. What Funding for Lending allowed banks and building societies to do was to borrow money directly from the Bank of England at near zero rates. They soon realised that there was no need to compete for savers money anymore. Therefore since summer 2012, savers rates have been continually declining.

As the chart below illustrates, average variable cash ISA rates have halved from 2.6% in July 2012 to 1.26% in September 2013. Even those prepared to lock up their savings for two years are only receiving rates just over 2%, which after tax is substantially below the rate of inflation.

Funding for lending effect

Data source: Building Society Association – Variable cash ISA rates inc bonus

So now that the end of scheme has been announced, will rates soon return to previous levels? The likely answer is unfortunately no, as the effects of the scheme will be felt for a long time yet.  Banks will still have funds on their books from the scheme that they have yet to allocate and so the need to tempt depositors back again will only gradually return.

However I suspect savings rates will start to increase over 2014. Moreover I may go so far as to predict that just before the election in May 2015, we’ll finally see inflation matching rates again.  In order to win the next election, it is going to be key for the Collation that the savers of this nation return to a bit of that feel-good factor we had during the Olympics.