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Where are we in the savings rates cycle?

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In his latest blog, Derek Sprawling, Paragon Bank Savings Director, discusses the latest trend in savings rates.

The final quarter of 2023 saw something that we haven’t experienced for a long time – relative financial calm. After what seemed like an extended period of fiscal volatility and frenzied headlines of economic Armageddon, it was a period of stability.

The inflation we experienced in the aftermath of the pandemic finally started to come down, prompting the Bank of England to pause its programme of interest rate increases. House prices stabilised and, for the first time in two years, savings rates were higher than inflation.

However, in the final weeks of the year, savings rates started to drift down and I would expect we are past the peak of the current cycle. A sharp reduction in inflation followed a period of savings rates being inflated by individual savings providers to cause a step down in December.

There’s still plenty of good news for savers, they can still secure rates above the expected outlook for Base Rate and certainly more than the rate of inflation. With inflation expected to fall further in the coming months, the gap between the two should widen, meaning savers’ cash is growing in real terms.

Holding steady

However, with the Bank of England holding the Base Rate steady since last August, the consensus is that the next move will be down as it seeks to balance taming inflation to 2% and stimulating the economy.

Some commentators believe the first Base Rate cut could come early, although the Bank of England Governor Andrew Baily has been keen to temper any expectation of a rapid reduction in rates. Higher for longer has been a term he has regularly used. 

Nonetheless, the financial markets expect the Base Rate to be heading down in the next few years, as evidenced by the reduction in ‘swap rates’. These are based on the future expectation of where interest rates will be at the end of a given period and are used by financial institutions to price their savings and mortgage products.

At the time of writing before the new year, the financial markets are pricing one-year swaps at 4.9% and five-year swaps at 3.6%, which means the markets expect Base Rate to be between 4.75% and 5% this time next year and around the 3.5% mark in five years.  

The relationship between mortgages and savings rates is inextricably linked. Put simply, the savings that banks look after are used to fund their mortgage lending, so where mortgage rates head, savings rates will follow.

Both have been drifting down and we would expect to see further reductions if the inflation rate continues its descent towards the 2% target. If the Bank feels the heat has been taken out of the economy, it will have more room to bring the Base Rate down.

Long-term economic health

However, whilst it’s impossible to make concrete financial predictions, it is very unlikely we will return to the days of ultra-low Base Rates of the years that followed the global financial crisis and into the pandemic.

Although we got used to super cheap money, that was detrimental to savers and was ultimately not healthy for the long-term financial health of the economy. Other factors that could underpin savings rates include individual providers' own requirements, plus the need for banks to repay money borrowed during the pandemic to keep liquidity in the economy.

But rates will likely come down and savers need to be prepared for that, most likely by saving with Specialist Banks with more niche business models designed to operate with consistently competitive savings rates.

Follow Paragon Bank’s blog  to read more savings market news.

Paragon Bank PLC is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England number 05390593. Registered office 51 Homer Road, Solihull, West Midlands B91 3QJ. Paragon Bank PLC is registered on the Financial Services Register under the firm reference number 604551