New weapon to boost savings rates

The financial watchdog the FCA is barking and growling at banks over the way they let down customers over savings rates.

In too many cases the saver is left languishing on a pitiful rate, given little information on how bad it is and seldom encouraged to shop around for something better.

So the FCA has devised a shiny new weapon to cow savings providers into behaving better. When they write to you with a regular statement they will have to include a "switching box" which shows in a colourful chart how bad your rate is, how much more you could get from the provider's other accounts and what you could earn from the average of the best ten savings accounts on the market.

Here's what the box could look like:

Another innovation is that when you get the account in the first place they'll have to include a warning if the rate is a poor one, saying it pays "interest below the bank of England's base rate".

The watchdog has retreated with a whine and a lowered tail from drastic measures such as banning the introductory bonus rates which makes accounts seem attractive at first but leave you stuck on a measly rate later.

But the switching box could be a big embarrassment for banks and building societies which take advantage of gullible customers.

All the measures are up for consultation.

Half per cent interest rates for longer?

"It is perfectly possible that, as time moves on, the right thing to do will be to keep the Bank Rate at ½ per cent even when unemployment has dropped below our seven per cent threshold," said Martin Weale, a member of the Bank of England's rate setting committee, the MPC.

He was trying to explain the Bank's interest rate policy to A Level students this afternoon: no easy task!

It adds to the Bank governor, Mark Carney's statement this week that:

“One can imagine a scenario where the unemployment threshold is reached, and that the best policy choice for the Monetary Policy Committee in that period of time is to keep rates at current levels, because the trade-off between output and inflation is attractive because we can keep inflation on target and can grow the economy further.”

All this is in the context of Forward Guidance, the Bank's attempt to give us fair warning about when it might raise interest rates. The threshold for considering a rate hike, we had been told, was a fall in unemployment to 7% of the workforce.

Despite acknowledging that the economy is recovering much fast than the Bank of England expected, they clearly want to keep us anchored to the view that they might stick to rock bottom rates if they see fit.

Will low unemployment trigger higher interest rates?

So this is an interesting point arising from the evidence Mark Carney is giving to the Treasury Select Committee. If unemployment drops to his threshold of 7%, does that automatically mean interest rates will be pushed up by the Bank's Monetary Policy Committee?

Perhaps not.

Because he's told them: "The 7 per cent threshold is a staging post. When we get there we have to evaluate what has happened to productivity, what are the broader labour market indicators."

On the one hand the Bank is saying it will take 3 years to get down to 7%. On the other, City econimiosts are saying the threshold might be reached in just a year or two.

But the MPC does have to move as soon as the threshold is reached. Carney has reiterated that 7% is the point at which the " MPC will consider tightening".

Carney stick with low interest rates

The governor the Bank of England, Mark Carney, has stuck firmly to the Bank's new policy of keeping interest rates low until unemployment falls to 7 per cent. He was answering questions from MPs in the Treasury Select Committee.

In an approach known as forward guidance, the Bank's Monetary Policy Committee has made it clear the rates will be kept down at the historic low of half of one per cent until the unemployment threshold is reached, most likely for three years.

He acknowledged there were forecasts in the financial markets that interest rates might end up being raised later next year or in 2015, saying "On average the view of the market is that the threshold will be achieved sooner."

But he gave no signal that the bank was changing its stance, adding "What's important is that this about the conditions when the MPC will consider tightening. That is summarised by the the 7 per cent threshold."

Challenged on the plight of savers, still destined to put up with paltry interest rates for a long time to come, he said he had "tremendous sympathy for them".

He said "They've done the right thing, they've set money aside."

"With growth will come higher interest rates for those savers. Our job is to make sure this economy reaches escape velocity and can sustain higher interest rates."

Savings rates cut in half

Interest rates for savers have plummeted since the Bank of England started to channel cheap money to banks and building societies last August through the government's Funding for Lending Scheme.

The point was to cut the price of mortgages and that seems to be working (boosting lending to small businesses has been a bit more of a problem).

But the Bank of England's latest figures show that the average Individual Savings Account (ISA) is paying just 0.69%, half the level of last summer.

The ones with first-year bonuses have dropped to 1.4% from 2.6%.

Normal savings accounts (not tax free ISAs) haven't dropped so much, but they tend to pay lower interest rates anyway.

Banks just don't need to attract your savings. They can get their funds elsewhere.

More pain for savers

Banks and building societies are withdrawing special bonus rates for savers, leaving them struggling to find a decent return for their money.

Savings accounts often come with a first year bonus of around 1%, to add to the normal interest rate, to attract new customers.

But the number of easy access accounts offering bonuses has fallen from 73 to 46 since August last year. The number of notice accounts with bonus rates has more than halved: only 11 remain.

The financial information firm, Moneyfacts, blames the government's new Funding for Lending scheme, which is channelling cheap money to banks to encourage them to lend.

There's already been a drop in the underlying rates of interest on offer to savers.

Savings rates collapsing

Savings rates have started to "collapse" as a result of a government scheme to encourage lending, according to the financial information service, Moneyfacts.

The £80bn Funding for Lending Scheme (FLS), which allows lenders to borrow from the government at cheap rates, has reduced their need to raise funds from savers.

"The immediate knock-on effect has been the collapse of savings rates across easy access, notice accounts and fixed bonds," according to Sylvia Waycott from moneyfacts.co.uk.

"And the devastation hasn't been limited to just the providers who have joined the FLS."

The highest paying instant access savings accounts for someone depositing £10,000 is down from 3.2% in August to 2.5% now, with the average rate dropping below 1%.

Moneyfacts says that the average one year fixed rate account is down half a per cent to 2.24% since August. Average interest rates for Cash ISAs and notice accounts have fallen as well.

Cut in Bank Rate "under review"

The country's benchmark interest rate is "under review", after the Bank of England's Monetary Policy Committee (MPC) considered cutting it from the current historic low of 0.5%.

Nothing is happening for "the present time", but it is significant that the Bank has shifted from its previous view that a further cut in rates, recently suggested by the IMF, could backfire.

It's worrying news for savers, who are already suffering from very low rates on the nest eggs - but potentially helpful for millions of homeowners on tracker mortgages (which track Bank rate), who would see a cut in monthly payments.

Here's the meat of what the MPC discussed during its meeting on 6-7th June:

"In March 2009, the Committee had judged that a reduction in Bank Rate below 0.5% could have counterproductive consequences, in particular constraining some banks’ and building societies’ ability to lend.

Lenders were, in practice, unable to reduce deposit rates below zero.  But they had assets – primarily mortgages – with interest payments contractually linked to Bank Rate. Consequently, a reduction of Bank Rate below 0.5% might squeeze some lenders’ interest margins to such an extent that they became even less able to extend new credit.

On the one hand, there was some evidence that the proportion of outstanding mortgages contractually linked to Bank Rate had increased since early 2009, as a number of borrowers’ fixed rate deals had expired and they had moved to paying pre-set rates linked to Bank Rate.

On the other hand, since early 2009, retail deposit rates had increased somewhat.

So it was possible that lenders had greater scope than before to absorb a reduction in Bank Rate by cutting deposit rates without adverse cash-flow onsequences.  The extent to which this would be possible would depend on whether other funding costs also fell in line with Bank Rate.  In addition to this, it was possible that, were interest rates to fall further, the functioning of the money markets would become impaired.

Overall, the Committee judged that, at the present time, a further reduction in Bank Rate would not have any advantages over an expansion of the asset purchase programme, though it would keep the position under review."

If the Bank cuts rates...

It seems a long shot that the Bank of England would cut its base rate by 0.25% today, something the IMF suggested last month would be a helpful move. A reduction would leave the rate at a new record low of 0.25%.

But if it did, who would be affected?

Mortgage borrowers would feel the most immediate impact.

Around 2.5m households are likely to be on base rate trackers. That means their mortgage payments are tied to Bank base rate and go up or down as the rate moves.

In addition, at least a million are on a special form of Standard Variable Rate which would change. Their interest rates can't be more than 2% higher than base rate. Since they're at the maximum level already, a cut today would mean a cut in their payments.

So between 3.5m and 4m households could gain. A typical repayment mortgage of just over £110,000 would be £14.84 cheaper a month after a 0.25% reduction.

Other people on SVR would have to wait to see if they were affected, possibly not, while the large numbers on fixed rates wouldn't see any benefit.

What about savers? Their fear is that returns would dwindle even further.

Some banks would be likely to use a base rate cut as an excuse for lowering rates. However, the linkage is much less clear.

The current best savings rates of around 3% for an instant access account are kept up by desperation on the part of lenders to raise cash to lend out as mortgages.

Banks and building societies are cutting back lending because it's still tricky to raise the cash from international financial markets - savers are the only solid alternative.

In any case, those 3% accounts are only offered as a lure to bring in new deposits. The average interest rate is 0.22% for instant access savings at bank branches and 0.66% for tax-free cash ISAs.

Those paltry rates aren't likely to change much, even if the Bank tries to make money cheaper.

Zero % Interest Rates?

Would the Bank of England cut its base interest rate below 0.5%?


If it did, what would the effect be - or is the idea a red herring?


The notion has resurfaced because the IMF has called on the Bank of England to consider cutting its rate even further.


Here's the possible impact:


Borrowers


People with tracker mortgages are the winners - their monthly payments would be cut. Some borrowers on Standard Variable Rate mortgages would benefit too, if they have a guarantee that the rate won't vary too much from base rate.


New mortgage offers - unlikely to be affected much.


Credit cards, overdrafts, personal loans. All these tend to move independently from base rate.


Savers


Sounds like terrible news for people depending on savings interest.


But the best savings rates, around 3% variable, are governed more by competition between banks and building societies - as they try get hold of our cash to give them something to lend out.


So the rates on offer might be affected very little, if at all.


Stretching banks


In fact, the effect of cutting Bank base rate might be to put our beleaguered banks under even more pressure.


They'd have to cut some customers' mortgage payments, but would still have to pay top dollar - or top pound - for savings.


"Their balance sheets would be even more stretched," warns Ray Boulger, mortgage expert at John Charcol.


So...red herring?


The IMF message is bound to prompt discussion at the Bank of England. But that doesn't mean action.


If its Monetary Policy Committee can't see a useful result, they're unlikely to push base rate further down into uncharted depths.