21 Jan 2011 | Capital Hill

Capital Hill on...Saving and borrowing rates 

It’s almost two years since interest rates fell to 0.50% (in March 2009), heralding a torrid time for savers and boom time for those on cheap tracker mortgages. But how exactly do savings and borrowing rates interact, and has this changed since the onset of the credit crunch?

Let’s look at savings rates first. Banks and building societies have slashed savings rates amid the historical low Bank rate, hitting loyal savers the hardest.

More than a third of savers hold money in an account they opened six years ago or more, according to consumer group Which? Money: some 87% of these accounts now pay interest of 0.50% or less, while 62% pay 0.10% or less – yielding a pitiful £1 a year for every £1,000 saved.

Those who continually switch to the best deals on the market have fared better. When money markets froze, banks had to raise funds for mortgage lending through savers’ deposits – and had to pay a premium to attract business from competitors. The margin between Bank rate and the average one-year fixed-rate bond is 2.11% today, compared with 0.26% in September 2007, when the near-collapse of Northern Rock sparked the biggest run on a British bank for more than a century.

Nevertheless, people are still struggling to maintain the purchasing power of their savings. With inflation running at 3.70%, as measured by the Consumer Price Index, basic-rate taxpayers need to find a savings account paying 4.63% per year simply for their money to maintain value in real terms, while those who pay income tax at 40% need to get at least 6.17% on their savings.

According to Moneyfacts.co.uk, the financial data website, there are 22 accounts which keep pace with inflation for basic-rate taxpayers to choose from, including 19 ISAs accounts.  Higher-rate payers have 19 accounts to choose from, all of which are ISAs.

Against this backdrop, savers have turned to the stock market in their search for income. Global income has been a growth area – a trend that is expected to continue. While this entails taking on equity risk compared to holding cash savings, investing in a diversified portfolio of high-yielding blue chip stocks in developed markets (the UK, Europe and US) will help to mitigate risk. So called emerging markets (many now seem beyond the point of just emerging) may have been more volatile in historical terms, but many fund managers believe that it is these markets – the likes of China, India, Russia and Brazil and many other smaller countries– that will yield the rosiest opportunities for both capital and income-seekers in the next few years.

Now, what about borrowing rates? These are traditionally linked to ‘swap rates’ (for fixed-rate mortgages) and ‘Libor’ (for tracker deals) – broadly speaking, the rates at which institutions lend to each other.

In July 2007, banks were losing money on their lending, with the margin between two-year swaps (what banks paid) and the average two-year fixed-rate mortgage (what they charged borrowers) standing at -0.05%. However, that margin rose to 3.19% last September and stands at 2.87% today.

As Michelle Slade at Moneyfacts recognises: “Part of this increase is down to the increased risk of customers defaulting on their mortgage debt. However, some of this margin will be being used [by banks] to repair dented balance sheets.”

Banks using savers deposits to fund mortgage lending have also increased their margins. In October 2008, the average five-year fixed-rate mortgage was 1.33% higher than the average five-year fixed-rate bond. That margin rose to 2.76% in March 2009, and has gradually fallen back to stand at 1.29% today.

Meanwhile, lenders continue to cherry-pick the best borrowers – those with sizable deposits and clean credit histories. With many borrowers reverting to rates as low as 2.50%, they’re staying put until it looks like the Bank of England is poised to raise interest rates.

Be ready to move: lenders will be quick to hike borrowing rates and slow to increase savings rates to again boost their profit margins at the expense of consumers.

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, Media Hill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.