July 2010 Commentary

No easy way to beat inflation as NS&I withdraws index linked savings certificates 19th July 2010

NS&I announced today that Index-Linked Savings Certificates have been withdrawn from general sale. It has also withdrawn Fixed Interest Savings Certificates and reduced interest rates paid on Direct Saver and Income Bonds.

Figures published last week by the Office for National Statistics showed that inflation, as measured by the Consumer Price Index (CPI), is currently running at 3.2% p.a. Retail price inflation continues to be significantly higher at 5% p.a.

Prior to their withdrawal, index-linked savings certificates were offering a tax-free return of 1% above retail price inflation. This allowed consumers to invest safely and be certain that their savings would keep pace with inflation. However, the maximum limit was £15,000 per issue, so some savers could not fully protect their savings against inflation.

The remaining products on offer from NS&I offer a maximum return of 1.75% gross, significantly below current inflation rates. This means that consumers no longer have an easy way to protect their savings against inflation. A basic rate taxpayer would need to earn a gross return of 4% to keep pace with CPI inflation; whilst a 40% tax payer would need to earn 5.33% and a 50% taxpayer would need to earn 6.4%. In today's low interest environment these levels of returns will be difficult or impossible to achieve on cash deposits.

The key question for savers is how long inflation will stay at these high levels whilst at the same time deposit rates remain low. One member of the Monetary Policy Committee (MPC) believes that the Bank of England should gradually increase official interest rates in order to bring inflation down towards the MPC's target of 2%. Last month Andrew Sentance, an external member of the MPC, voted for a rise in the base rate. In a speech to the Thames Valley Chamber of Commerce last week he outlined his reasons for believing rates need to rise to reduce inflation.

Sources:
ONS: Inflation report
Bank of England: MPC June 2010 minutes
Speech by Andrew Sentance, at the Thames Valley Chamber of Commerce, Reading on 13th July 2010 UK Monetary Policy - How long should "The song remain the same"?