“With the International Monetary Fund (IMF) predicting that interest rates will be rock-bottom again once inflation is under control, what should I do with my savings? It has taken years for rates to return to the sort of levels they are at now, and I don’t want my money to be earning almost nothing again.“
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UK interest rates have increased significantly over the past 16 months as the Bank of England tries to tame surging inflation.
In December 2021, the base rate – the benchmark for most savings and mortgage products – was at a record low of 0.1%. Today, it’s 4.25% and, as a result, savers can earn as much as 7% interest on their money.
But this may not last for long. This week, the financial agency the International Monetary Fund (IMF) released a report on the future of interest rates. The report described the last eleven rate rises as somewhat of a blip. It also predicted UK interest rates will slide back to rock bottom levels once inflation has passed.
Read more: Best savings accounts in 2023
The IMF noted that inflation is subsiding more slowly than anticipated which has led to higher interest rates for longer. But it predicts eventually rates will return to near-zero levels. These low interest rates ruled between the financial crisis and the end of the pandemic.
This could provide relief for homeowners and business borrowers who have been hit by dizzying increases in their monthly payments. But the IMF’s predictions will be sobering for savers who are finally benefitting from decent returns. So should you be worried about UK interest rates going down?
When will UK interest rates start to fall again?
First of all, it’s worth noting that the IMF has not specified when it expects interest rates to begin their descent.
Inflation had been starting to fall: it peaked at 11.1% in the 12 months to October 2022 but was down to 10.1% in January. Then, however, it shot back up to 10.4% in February.
It’s likely that for as long as inflation is rising, the Bank of England’s base rate will too.
In fact, last month, the Bank’s governor, Andrew Bailey, said rates will continue to rise if inflation is not brought under control.
However, he added the Bank was currently “pretty confident” that inflation will “fall sharply” from the early summer.
Another way to look at this all is through the lens of the banks, which tend to price products according to not just the base rate but also “swap rates” – the price they pay on the financial markets for funding for their own operations. And the level at which these rates are set reflects market expectations of what the base rate will be in the future.
Generally, the longer you are willing to commit your money to staying in a savings account, the better the interest rate you will be paid – because a bank or building society has the certainty of holding your cash for that period.
Over the past few weeks, however, providers have been offering similar rates on five-year fixed-rate savings accounts to those on one or two-year fixed deals, with the best deals pitched at about 4.5%.
This tells us the market expectation is that the base rate is nearing its peak and may even fall in the coming months. Why, for example, would providers go all-out to entice savers to grab the opportunity of earning 5% interest a year in four years’ time, when interest rates might have dropped to 2%?
So what can you do with your savings?
Those savers who have their money in an easy-access variable-rate account, and are worried about rates falling, could consider switching to a fixed-rate account while these deals are still paying rates of interest not seen since before the financial crisis 16 years ago.
These accounts lock your money away for a set period at a fixed rate of interest. That offers security. But bear in mind that if you need access to the cash before the account matures then you might have to pay an exit penalty. So it’s only generally worth it if you’re confident you won’t need the money during the fixed term.
A way to mitigate this is by having some money in an easy-access savings account set aside for any emergencies or other big, unplanned expenses.
The best fixed rates are currently being offered by lesser-known challenger banks. SmartSave recently launched market-leading one and two-year fixed-rate savings accounts paying 4.52% and 4.58% respectively. Cynergy Bank is offering 4.57% fixed for three years, and Tandem 4.6% for five years.
Interest rates on fixed deals have had a particularly volatile time since last autumn. They surged in the wake of Kwasi Kwarteng’s tax-cutting mini-budget in September because banks and building societies were influenced by market expectations, as reflected in swap rates, that the base rate could hit 6%.
But when Jeremy Hunt came in as chancellor and axed most of Kwarteng’s plans, those expectations faded and the returns on offer to savers fell.
In the past month, they have crept back up again along with swap rates, with the Bank of England’s monetary policy committee being widely expected to increase the base rate again at its next announcement on 11 May.
Beyond this, however, the forecasts are for inflation to fall, and so interest rates could follow – although by how much they might drop in the UK, notwithstanding the IMF’s forecasts, isn’t yet clear.
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Rachel Springall at financial website Moneyfacts explains: “Shorter-term fixed savings accounts can be a preferred choice amongst savers right now, however, typically a longer-term fixed bond is more attractive if there is an expectation for interest rates to plummet.”
Springall argues, though, that waiting for even higher rates could backfire as many of these products are being offered by challenger banks, which may pull their deals once they hit their quota. “Savers,” she adds, “may need to act quickly to grab a top rate.”
See our guide for the best fixed rate savings accounts right now.
How long should I fix for?
How long you fix for depends on where you think the market is heading and when you will need to access your savings.
If you are unlikely to need the money for several years, you could consider locking it away now. This way, even if interest rates fall sharply, you will still be receiving a good return.
You may even beat inflation. For example, if you locked in a three-year fixed savings deal paying 4.5% today, and inflation fell to the Bank’s target rate of 2% in 2024, you would beat inflation in the second and third years.
You may be better off fixing for a shorter term if you disagree with current forecasts and think rates may continue to rise. If you do this then you can take out a new fixed-rate deal when that one expires.
If you’re unsure, you could save half in a longer-term deal, put the rest in a shorter-term one. This would mean taking your chances with what rates will be when that fix comes to an end.
You might want to speak to a financial adviser too. They will be able to take a closer look at your personal finances and work out the best option for you.
