We have seen such a massive change in interest rates and Government policies in the last six months that it is probably best to take a step back and reflect on what this means to us now, and what effect it may have in the future.

I have been saying to clients for quite a while that the situation we had during 2007 and 2008 was exceptional. It was possible to access interest rates well above the Bank of England base rate and as a result holding cash in a high interest rate account was not only attractive, but also meant you could achieve a real return against inflation. This was an anomaly, as since the war, the average rate of inflation has far outstripped the amount of interest earned by having cash in the bank.

However, reality is now biting. Just last week a client called to ask if she could get a better rate for her cash ISA with Alliance and Leicester. I was ignorant of how far these rates had fallen and was shocked to find that all she was earning was 0.2% per annum. On a balance of £20,000 that means interest of £40 in a year. By having it in an ISA she was saving herself £8 per annum in tax. That’s a relief then.

Alliance and Leicester are not alone. Both the Abbey and HBOS are paying 0.1% on their equivalent products, with the average amongst the big banks being around 1% per annum. Ridiculous.

The cynic in me believes banks have reduced their cash ISA rates more than other accounts as they believe their customers either won’t be aware of the new rate, or more likely, won’t be aware that they can transfer their ISA’s to other banks and building societies, or even into a stocks and share ISA. However, it is not only ISA accounts that are paying rates that would have been unthinkable only four months ago, and it seems unlikely we will see an improvement in rates anytime soon.

The flip side of this however, is that the cost of borrowing is getting ever cheaper. The same day as I heard from the client above I received an email from another asking for advice as they will be paying £1,000 per month less to their mortgage from March. Unfortunately for Gordon Brown’s recovery plans they wisely plan to save this additional cash rather than spend it.

So where should anyone with large sums of cash on deposit look to achieve a better return?

Within our industry everyone seems to suggest Corporate Bonds are the best bet, but I do not believe they are for everyone. For the braver out there high yielding equity income funds could give an excellent return as they are paying dividends well in excess of interest rates at present, and have decent prospects of achieving capital growth in the longer term. Indeed funds that combine both Equities and Bonds are probably a reasonable alternative as they allow the manager to move between these and other asset classes as they see fit. However, all of the above are long term investments and not ones that should be made unless you could be confident of not needing to access the funds for at least five years.

For those who require access to funds whenever they wish without any risk, unfortunately, bank accounts remain the only real option.

There is however a bogeyman potentially on the horizon in the shape of inflation. A bit like the terrible bush fires we have seen in Australia, inflation once created can be almost impossible to extinguish. Although Government easing of monetary policy is really the only medicine available to help us at present, history tells us when this has happened in the past, inflation has been the inevitable outcome.

By that I don’t mean the 3 – 4% range that currently requires a letter from the Governor of the Bank of England to the Chancellor explaining why he has been a naughty boy. No, I mean double digit stuff, which those of you who can remember the 70’s and 80’s will be well aware of. Inflation at that level not only drastically erodes the real value of deposits, but also causes havoc for those on a fixed income such as pensions.

It does however benefit those with debts, as in real terms the amount that needs to be repaid falls by the day. Given the record amount of Government borrowing that is planned for the next couple of years, a cynic may think they would not view inflation as such a bad thing!

Let’s hope it doesn’t come to that, but don’t be surprised if you start hearing the “I” word being mentioned in the months to come.


Steven Forbes is Managing Director of Alan Steel Asset Management