Author: Anna Bowes | Co-Founder – Savings Champion
16th May 2024
It’s a bit of a double whammy! The new tax year and the start of spring (although the latter is proving a bit more fickle) are both a good reminder that it’s time to do a bit of spring cleaning of your finances.
And, although it keeps getting pushed back a little, it’s looking more and more likely that the UK could soon be cutting interest rates, even moving ahead of the US’s Federal Reserve. In the US, the economy is buoyant – and that is keeping inflation higher than expected so a drop in interest rates could come later.
Whilst the latest UK inflation figures came in a little higher than expected, at 3.2% the Consumer Prices Index (CPI) is still the lowest it’s been in two and a half years – and the trajectory is in the right direction. It reached the dizzy heights of 11.2% in October 2022 so has fallen a long way back since then.
As a result, if you’ve not already taken advantage of the higher rates on fixed term bonds that we’ve seen over the last couple of years, now could be the time to fix at least some of your cash, to hedge against the expected rate cuts to come later this year.
Will interest rates go down?
One really telling indication that interest rates are likely to fall, is that longer term rates are lower than short-term rates. This inverted curve is unusual, as you would normally expect to be rewarded for locking your money up for longer. But, at the time of writing, the top five-year bonds are paying around 0.70% less than the top one-year bonds. This doesn’t mean you should ignore the five-year bonds; whilst the higher rate looks much more attractive at the moment, what will be available in a years’ time, when that bond matures? And the year after?
Of course, without a crystal ball, there is no way of knowing which route will provide you with the most interest, so perhaps a balanced savings portfolio is the way forward – splitting your cash into a few different terms, plus keeping some available for immediate expenses or to take advantage of any surprising offerings that may become available.
ISA allowances
Another thing to deal with sooner rather than later, is to use your ISA allowance, especially if you are going down the cash ISA route. This is because the sooner the cash is sheltered in an ISA wrapper, the sooner the interest is tax free. This is of course particularly important for those taxpayers who will be using their Personal Savings Allowance this year. With interest rates of 5% or more, a basic rate taxpayer will bust their PSA with a deposit of just £20,000.
As savings rates started to rise in 2022, initially ISAs were largely ignored – instead there was a pretty fierce battle in the fixed rate bond tables. As a result, the gap between the top paying bonds and equivalent ISAs increased to more than 40% – far more than the tax benefit of putting money into these tax-free savings accounts. For example, in August 2021 the top 1-year bond was paying 1.38% before the deduction of tax – 1.10% if basic rate tax was deducted and 0.83% if higher rate 40% tax was accounted for. The top ISA on the other hand was paying just 0.80% – less than the rate even a higher rate taxpayer could have earned on the bond.
But the good news is that as a result of rising interest rates, savers began turning back to ISAs to shelter their cash, and that has generated some competition between providers, closing the gap between the top rates of bonds versus ISAs significantly. So now, anyone paying tax on their savings could earn more by putting their money into the ISA.
Either way, bond or ISA, the consideration is the same. Whilst a longer-term savings account might offer less interest immediately, with inflation falling it would be good to think that at least some of your cash is earning an interest rate that is higher than inflation for longer – something that is rarely the case.
Although this article may contain helpful information and tips, it is not personal advice. You may wish to seek advice from a financial advisor if you are unsure what’s best for your own personal circumstances.