How changing interest rates affect your savings
Interest rates affect what you can earn on your savings accounts – and it could be good news when they are on the rise. Our guide explains more about how they work
FEBRUARY 2024: The Bank Rate is 5.25%, after the Bank of England once again voted to freeze the base rate.
Interest rates tend to increase when the cost of living and inflation are rising above a level the Bank of England is comfortable with.
Rising interest rates are designed to curb spending and slow the rate at which prices are increasing to keep the economy stable.
While it makes borrowing more expensive, rising rates can be good news for savers who stand to earn a higher return on their account balance.
What are interest rates?
Interest is the reward banks, building societies and other savings providers pay you for putting your cash deposits with them. The official ‘Bank Rate’ is set by the independent Bank of England. But this is the rate other financial institutions use as a guide to set their own commercial interest rates – for borrowers and for savers.
The best way to view it is that interest rates tell you how high the rewards are for saving – or how much it will cost you for borrowing.
The higher the interest rate, the larger the return you can expect to receive on the money you put away in a savings account. But conversely, the more expensive a mortgage, loan or credit card is likely to be.
For example, if you had savings of £1,000 and the interest rate was 2% per year, you would receive around £20 in interest in one year.
In reality savers are likely to earn just over £20 because the interest is usually compounded – meaning you will earn interest on your interest. It means for example, if the interest rate stayed at 2% for the next five years, your savings balance would increase to £1,105.
How does the Bank of England interest rate affect my savings rate?
The Bank of England Bank Rate or Base Rate is the interest rate set by an independent group of economists working within the Bank of England called the Monetary Policy Committee (MPC).
The interest rate set by the MPC helps dictate the level of interest set by other banks and building societies in the UK – as shown by comparing average savings rates (from UK banks and building societies) with the Bank of England base rate over the past five years.
Why did the Bank of England raise interest rates?
For a sustained period in 2022 and 2023, the Bank of England opted to hike interest rates to try and tackle sky-high inflation, which peaked at 11.1%.
The Bank has a target to keep inflation below 2%, but the cost of living has soared in the past few years because of rising energy prices and the high cost of goods from abroad.
According to the Office of National Statistics, in December 2023 inflation fell to 4% - sparking hopes that soaraway inflation is gradually coming under control and that the Bank of England could start to trim the base rate in the medium term.
Will I benefit from rising interest rates?
Savers benefit from rising interest rates because the money they have in savings accounts should earn greater returns.
Although it does depend on what type of savings account you have. If your savings interest rate tracks the Bank of England rate then you’ll benefit in full from any base rate rises.
If not, your interest rate might rise by slightly more, less or not change at all – it depends on the decision of your savings provider.
Often there is a lag between the base rate rising and providers putting up their own rates.
However, the good news for savers is that with an increase in the base rate the savings market as a whole is on the up – so better deals are available.
This table show how much savers can benefit from a rise in savings interest rates, with compound interest and an initial savings balance of £5,000.
Savings interest rate
How can I take advantage of rising savings rates?
Shop around for the best deals: Regularly compare savings accounts to see who offers the highest rate and take advantage when these come up. It only takes a few minutes to open a new account online and move your savings pot (if there are no penalties to switch from your existing account) to the new provider.
Look for bonus rates: Some accounts will offer bonus rates to entice new savers. Take advantage of these where possible, but also note when the bonus period ends. Often the rate will plummet after the bonus offer period – so make a note to move your savings again.
Consider how long you’re prepared to lock your savings away. A fixed rate bond could look enticing, but if interest rates are on the rise you may find better deals become available in six or 12 months’ time. It’s important to weigh up the risk of fixing now, versus lost interest due to waiting for higher rates.
How is interest paid on my savings account?
Interest on savings accounts is the amount of money the bank or building society pays the depositor for keeping their money in the account. You'll be paid either a fixed or variable rate of interest.
Fixed interest means you'll be paid at a set rate which won’t change during the term of the account.
With a variable interest rate, the amount you earn could go up or down at any time, and the change is linked to movement in the Bank of England base rate.
Interest in the UK is usually paid as compound interest. You’ll earn interest every day, but it is usually paid back into your savings account monthly, although some accounts may pay quarterly or even annually.
If unsure, your provider will be able to tell you how often interest is paid on your account.
What is compound interest on savings?
Compound interest has a snowball effect in helping your savings grow. You’ll receive interest on your deposited amount, plus interest on the interest.
Interest can be compounded daily, monthly, or quarterly. The more frequently interest is added to your balance, the faster your savings will grow.
The alternative is simple interest which is only paid on the principal or deposited amount.
What does gross interest mean?
Gross interest means the amount of interest you will earn before tax is deducted. Net interest is the rate of interest earned by a bank account or an investment after tax has been paid.
What does AER mean on a savings account?
AER stands for Annual Equivalent Rate. It is the interest rate used to make comparisons on savings accounts by taking into account compound interest, bonuses and any charges, to show how much interest you’ll earn over a full year.
Due to compounding, when you look at the monthly interest paid by an account the AER shown will generally be higher than the gross rate.
How can I get the best savings rate?
You can get the best savings rate by comparing the returns offered by each account as well as assessing the type of account and its individual terms.
For example, you might find that a fixed rate bond offers you the highest interest rate, but you will have to lock your money away for an extended period – and may face a charge if you try and withdraw it earlier.
Alternatively, a regular saver account could offer the best rate, but may not be suitable if you have a large lump sum to deposit initially.
Easy access savings accounts won’t typically pay the highest interest rates (although some are competitive) but do allow you to withdraw your money quickly. In a market where rates are on the rise, this could be of benefit in giving you the flexibility to swiftly move to a better account.
Also consider cash ISAs, which allow you to put your savings in a tax-free wrapper. Although savers now have the personal savings allowance – cash ISAs can still be of benefit where they offer competitive rates – and for those who have a large savings balance and could exceed the PSA tax free limit.
Our Expert Says
"Knowledge is power, especially when it comes to personal finance, so having a strong understanding of how interest works, and how you can use it to make your money work harder for you, is nothing less than a game changer. Always balance the interest rate you’ll earn against any charges or costs when considering a savings product though, and remember that, apart from money ‘wrapped up’ in an Isa, you may have to pay income tax on interest earned."
- Kate Hughes, personal finance expert
Useful guides on savings
We have a broad range of helpful savings guides, including:
Compare savings accounts with MoneySuperMarket
It’s quick and simple to compare savings accounts with us. You can filter results to see a range of easy access, fixed rates and cash ISAs and compare rates, deposit limits and important terms and conditions.
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