What Might a Change in the Base Rate Mean for Savings Rates?
Welcome to our November edition of ‘Insight’ by Insignis where each month, we discuss a topic of interest within the UK financial sector. This month, we are looking at what a change in the base rate might mean for interest rates in the UK savings market.
- According to historical data, an increase in the base rate does not necessarily translate to an increase in savings rates
- The base rate hitting 0.5% could trigger a large-scale sell-off in government-issued debt
- Anticipate a pause for breath in the short-term rate rises before an increase driven by strengthened competition for deposits
What is the base rate and is it linked to savings rates?
The base rate is the interest rate set by the Bank of England (BoE) and is the rate at which the central bank lends money to commercial banks. An increase in the base rate will not necessarily cause a change in savings rates as there is only a partial correlation. This is evidenced in the below graph which compares the base rate to the average 1-year fixed-term product offered by Building Societies. Between 2009-2013 the base rate was up to 6x lower than the average rate for a 1-year fixed-term product and despite a sharp decrease of the base rate at the beginning of 2009, savings rates remained relatively stable.
Quantitative easing post-2008
In an attempt to keep inflation at bay and stimulate the economy in the aftermath of the 2008 financial crisis, the BoE engaged in a practice called quantitative easing (QE). Initially, the base rate was reduced from 5% to 0.5% with the aim of promoting growth as consumer lending became more affordable. Whilst useful, reducing the base rate alone was deemed insufficient so a bond purchase programme was introduced whereby large quantities of bonds were bought from financial institutions by the government to promote lending from banks that were now awash with liquidity.
The inverse relationship between a bond’s price and its yield means that as the price increases, the yield decreases. This was realised when the BoE started its £895bn bond-buying programme, forcing investors to look elsewhere for competitive returns and driving alternative markets higher, thus stimulating growth throughout the economy.
Is this the beginning of quantitative tightening?
Fast forward to the present day and investors are increasingly concerned as to how the BoE is going to wind down this programme and perhaps more importantly, how quickly. Strategists forecast the base rate will increase by the end of the year from its current rate of 0.1% to 0.25%, but it is further increases that are particularly concerning to investors. Once the base rate hits 0.5%, the BoE has committed to reversing its QE programme and will not re-invest maturing bonds. Timing is crucial here as the BoE has £27bn in government bonds which are due to mature on March 7th so this could be an opportunity to start unwinding its position. If these bonds are not re-invested, they will be released onto the market creating a surplus supply and increasing yields, drawing investors away from alternative markets.
Are bank savings rates expected to increase?
Savings and deposit rates have already seen large increases over the past 6 months, particularly from so-called ‘challenger banks’. The savings ratio is falling back from its COVID related highs and a number of banks are offering a premium on rates to secure deposits. Moving forward, Insignis anticipates the recent rate increases to pause for breath until we gain greater clarity on both base rates and the overall resilience of the economy. On a medium-term basis, there are 10 new challenger banks due to enter the market in the next 12 months, so rates are likely to change as these competitors strengthen the competition for deposits.
How can Insignis help?
The current account rates available from high-street banks are still as low as 0.01%. Using the Insignis Cash Management platform will ensure your clients are maximising returns on their cash holdings, whilst simultaneously reducing risk as their funds are diversified across several institutions, maximising FSCS protection eligibility.
Insignis works with a panel of 34 Banks and Building Societies, providing access to market-leading rates in addition to the comfort often associated with the high-street banks your clients are familiar with. We constantly monitor the rate environment and remain proactive in communicating new rates to clients.