Newbie Question: Do saving accounts take into account inflation rate?

ashers1812

Hi Guys,

First post here and I have a nagging question.

Say you register a savings account at an annual rate of 5% and national inflation is running at 3%, does that mean your gain is really 2% instead of 5% or does the bank take into 'account' the rate of inflation and the 5% is the actual net rate???

Sorry for the length. If anybody can help, be much appreciated.

Cheers,

Ash:T

Liz_the_Whizz

Welcome to savings!

You are quite right in your first statement.

The growth on your savings is the difference between what the bank pays NET and inflation. So in your example, you get 2%, assuming 5% is net (ie after tax).

If 5% is gross (before tax), then once the bank has deducted tax, interest paid is c. 4%, so the gap with inflation is only 1%.

Banks are obviously aware of inflation, but their rates depend on lots of other factors, particularly how much money they need - especially at the moment with credit crunch when getting money via other means isn't quite so easy for them.

But they will also drop rates once they have enough. And lots of accounts pay way below inflation.

And while the governement want us to look at CPI inflation cos it's lower, most people still regard RPI (currently 4.1%) as more accurate (though still understating rising cost of living).

It's up to you to keep a close eye on your savings and make sure you are getting the best rate you can.

Aegis

Just to expand on Liz's final paragraph...

Inflation obviously isn't as simple as a single figure for everyone. If you were only paying gas bills this year, you'd be looking at an inflation level of much higher than the stated 2.1% for CPI or 4.1% ish for RPI. As such, you have to more or less set your own inflation rate and see how your savings do compared to that. Personally I think the RPI is a much more realistic figure to follow for most people, as it includes mortgage payments which will probably roughly correlate with rent payments, making it a better index to follow for anyone who doesn't own their own property outright...

If your savings rate beats your inflation rate, you're gaining money, otherwise you're not. However, the safety of cash as an asset can't be overstated here: it's about the safest way you can hold on to your money even if inflation eats away at it.

Jonbvn

Slightly OT, but if anyone has concerns regarding savings interest vs. inflation, then index linked savings certificates are worth considering. As an additional advantage, they are tax-free.

neilp

I would second that, but it is also worth bearing in mind that they key factor behind monetary policy decisions is inflation, which means that if inflation is rising, base rates will also tend to be rising, and this will drive up savings rates. Obviously, there are other factors (as we are seeing at the moment), such as growth and domestic demand, but in general I think that the relationship between base rates and inflation is a solid one.