The gap between the highest savings rate and CPI inflation is narrowing, and savers will wonder: When will inflation beat the savings rate?
For more than two years, no savings account has managed to match or beat inflation.
During that time, even savers who have deposited their money in the highest paying fixed savings accounts will have seen the value of that money gradually eroded by inflation.
The gap is narrowing: Keeping an eye on inflation is essential to know whether or not your savings are being eaten up by inflation
Finally, however, there is a glimmer of hope that the best savings rates will beat the pace at which prices are rising very soon.
Inflation fell to 7.9 percent in the 12 months to June, lower than market forecasts, which had expected 8.2 percent.
Meanwhile, savings rates have risen dramatically over the past month.
The best easy-to-access deal now pays 4.51 percent, up from 4 percent this time last month, while the best flat rate is up from 5.7 percent to 6.15 percent over the past month.
A year ago, in July, when inflation was 10.1 percent, the best one-year fixed savings contract paid 2.95 percent and the difference was a whopping 7.15 percentage points.
Easy access was increasingly wide — 8.2 percentage points between the best deal paying 1.9 percent and the rate of inflation.
However, with rates higher and inflation lower, the difference has narrowed to 1.75 percentage points between the best one-year deal and inflation.
The Bank of England expects inflation to fall to about 5 percent by the end of the year and to about 2 percent by the end of 2024.
If the Bank of England’s forecasts turn out to be broadly correct – and that’s a big one if they’re based on past performance – then savers currently locked into the best rates should be on track to beat inflation going forward.
The Bank of England expects inflation to fall to about 5 percent by the end of the year and to about 2 percent by the end of 2024.
Anna Bowes, co-founder of Savings Champion, believes we will also likely see the gap between the best easy-to-access rates and inflation shrink in the coming months. The difference is currently 3.39 percentage points.
Says Bowes, “While it looks like the rate hikes of the past 18 months are starting to have some effect on slowing inflation, it’s likely that a few more key rate hikes will follow, which should push floating rate bills higher.
“So as inflation continues to fall, we could see the gap shrink even more and maybe even pay a few bills more than inflation.
“Especially those who open a fixed-term account, especially if they choose a longer-term bond.
“The fixed rate market may have priced in all expected future increases and even overestimated how high it would go, which is why we could see top rates fall again.”
How could savers beat inflation?
CPI inflation measures rising costs over the past 12 months, so June’s inflation rate of 7.9 percent means that typical prices of goods and services were 7.9 percent higher than in June last year.
That means what cost someone £1,000 in June last year will typically cost them £1,079 in June this year.
The best one-year fixed-rate savings agreement paid 2.4 percent in early June last year.
Inflation fell to 7.9 percent in the 12 months to June, lower than forecasts of 8.2 percent.
A saver who deposited £1,000 in that account a year ago will have earned £24 in interest, but would need to have earned £79 to match inflation.
Today, someone who puts their money into the best one-year fix earns a rate of 6.15 per cent – that would equate to a return of £61.50 on £1,000 over a 12-month period.
The Bank of England expects inflation to be around 3 percent by the middle of next year. If all goes according to plan, this means that a saver in the best fixed rate deal will eventually well beat inflation.
It means that something that costs £1,000 today would cost £1,030 in 12 months.
Someone who put that same £1,000 in the best one-year fixed savings account would have increased their savings to £10,610.50.
However, there are two important caveats to all this. The Bank of England’s projections are ultimately just predictions. It is difficult to accurately predict how CPI inflation will develop in the coming years.
After all, the Bank of England has often made incorrect forecasts in the past.
By the end of 2021, the bank predicted that inflation would peak at around 5 percent in April 2022 and then fall back – which has clearly not been the case.
The second caveat is tax. At the moment, anyone who saves outside an ISA can expect a hefty tax assessment on his savings.
The current personal allowance offers little protection.
Base rate taxpayers can earn up to £1,000 tax-free interest each year.
Higher rate taxpayers can earn up to £500, while higher rate taxpayers (those earning more than £125,140) receive no taxpayer protection at all.
The personal savings allowance was introduced in 2016, when the base interest rate of the Bank of England was only 0.5 percent. Now it is 5 percent and the best savings rates are much higher.
Savers with big pots are therefore likely to see their total return after tax drop dramatically.
The best one-year fixed-rate deal pays 6.15 percent, courtesy of Vanquis Bank.
That means just £16,262 in savings would tip a base rate taxpayer on the amount of interest they can earn before tax is due. A higher rate taxpayer would only need £8,131 in the account to pay tax.
However, if that personal allowance amount has been used up, the real return (after tax) on a deal drops from 6.15 percent to 4.92 percent for those subject to the basic rate and to 3.69 percent for those subject to the higher rate.
Some links in this article may be affiliate links. If you click on it, we may earn a small commission. That helps us fund This Is Money and use it for free. We do not write articles to promote products. We do not allow any commercial relationship to compromise our editorial independence.