Mortgage Advice Centre

At the moment, it is very difficult to protect savings from being eroded by inflation.

CPI inflation is 3.5%. A broader measure of inflation RPI is 3.7%. Yet, with base rates very low (0.5%) it means we have a negative real interest rate.

Real interest rate = nominal interest rate (0.5%) – inflation (3.5%) = -3%

This is one of the highest negative real interest rates on record. Furthermore, there is no sign of a rise in interest rates. At least later in the year, inflation should fall back a little. – Some of the spike in inflation is due to temporary factors such as VAT and petrol.

But, the unfortunate reality is most savers are seeing a decline in the real value of their savings.

If you paid tax on your saving income, you would need a saving rate of around 4.2%. But, the average saving account is currently paying 0.88%. It’s not a good time to be a saver.

What Can you Do to Protect Savings from Inflation?

• Diversify into Government Bonds which offer higher interest rates. The drawback is that this is a volatile time for the value of bonds sold on open market.
• Look for a fixed-rate cash ISA.  from Leeds Building Society pays 4.6pc. THe drawback is that your cash is tied up for five years.
• Offshore Investments. Barclays are offering offer shore investment accounts which promise upto 6% AER.
• National Savings & Investments’ Index Linked Certificates. These offer savers a guaranteed inflation plus 1%
• Buy into Gold. The ultimate protection against inflation. Gold will hold its value and become more attractive during periods of inflation. However, G.Soros has described Gold as the ultimate bubble. It’s value can go down as well as up.

Recent Data showed a marked rise in inflation and a unexpected rise in unemployment.

CPI inflation is now 3.5%. Unemployment also rose. Those claiming job seekers allowance rose 23,500 to 1.64m in January. A broader measure of inflation – ILO method showed a small fall in unemployment to 2.46 million.

This rise in unemployment and inflation is an unwelcome combination suggesting a period of stagflation. However, the rise in inflation is mainly due to factors such as a rise in VAT rates and higher oil prices. There is no sign of underlying inflationary pressures. Spare capacity in the economy should keep inflation low.

With the economy still very weak, and some economists fearing a double dip recession, there is no likelyhood of any increase in interest rates in the near future. After the general election, the UK is likely to see some form of fiscal tightening (higher taxes, lower spending) to help reduce the budget deficit. This will keep the pressure on interest rates to remain low.

The economy could face a further slowdown this year because of:

• Recession in southern Europe – UK exports twice as much to Spain as China.
• Fall in Confidence following problems in Eurozone
• Rising unemployment in the public sector
• Expiration of stimulus packages.

The UK banking industry has become increasingly concentrated following difficulties of credit crunch. Numerous mergers have changed the nature of the banking industry. The top 5 UK owned banks by market share (Jan 2010) are:

1. HSBC – £122.29bn market value
2. Lloyds Banking Group – £36.26bn market value
3. Barclays – £35.51 bn market value
4. Standard Chartered – £31.42 – bn market value
5. Royal Bank of Scotland Group – £20.71 bn market value

6. Co-operative Bank -£39bn
Also Tesco Bank – owned by Tescos

The other major financial institution is the Nationwide building society. It has assets of £202.3 billion April 2009. Building societies are not listed on stockmarket, but, the difference with banks is less than it was.

HSBC

• also owns First direct)

Lloyds Banking Group

Lloyds banking group comprises:

• The UK Government owns a controlling stake of 43%.
• Lloyds TSB.
• HBOS – Halifax and Bank of Scotland
• Birmingham Midshires:
• Cheltenham & Gloucester:
• 50% of Sainsburys bank

Barclays

• acquired Woolwich)

Standard Chartered

• - few customers in UK, mostly in Asia

Royal Bank of Scotland

• 84% of the bank is owned by UK government.
• Subsidiaries include:
• Royal Bank of Scotland
• National Westminster Bank
• Ulster Bank
• Direct Line
• Coutts & Co.

Major Foreign Banks on UK High Street

Santander

• acquired Abbey,
• Alliance and Leicester
• and savings branch of Bradford & Bingley

Santander

Whilst the Spanish economy struggles with unemployment approaching 20% and a painful housing boom and bust, its major bank – Santander has made great strides in capturing market share in the UK.

Many of the large UK banks have been seeking to improve their balance sheets and have held back from lending new mortgages. Santander is one of the few banks which has been actively seeking new business – taking advantage of market conditions to increase their share of the UK mortgage market.

Santander recently published figures which showed its net lending had reached £7.6bn in 2009. This is almost 50% of the new market for mortgages. It gives the bank a market share of 20%.

It’s relatively new brand image on the UK high street seems to have been a blessing in disguise. With uncertainty over existing British banks, Santander has benefitted from £14.9bn of new savings.

Santander is in the process of rebranding Bradford & Bingley and Abbey branches with the distinctive red logo.

Santander are currently offering a  rate of 4.39% on their, no fee, two year fixed mortgage. This is better than by own mortgage company – Alliance & Leicester who recently offered me 4.99% for a three year fixed.

Related

• Guide to Mortgages
• Santander Mortgages

Source: B of E – Economic Recovery and Housing Market (pdf)

A few interesting questions in the current climate is:

- Why have UK house prices started to rise – despite house price to earnings ratios being above long term average?

- Why are UK house prices rising after only 18 months of decline – whearas after the 1990 crash, prices fell for four years?

- Why are UK house prices showing signs of recovery whearas Spain and US faced much longer and more persistent house price falls?

The above graph from the Bank of England goes someway to answering these questions. As house prices started to fall, homebuilders immediately started cutting back on new house builds.

Also, in the boom years (00-07), there wasn’t a boom in house building. There simply isn’t a large surplus of unsold housing stock that you see in the US, Spain or Ireland.

Strict UK Planning restrictions and shortage of land meant that when prices were accelerating there was no speculative bubble in house building.

In the 1980s, there was a greater rate of housebuilding that meant there was more unsold stock depressing prices through the 1990s.

There are still factors which will weigh down on UK House prices

• Threat of rising interest rates
• The fact house prices are still expensive for many in a climate of low real wage growth.
• Continued high unemployment.
• Recovery in market could attract more sellers who had been holding on.

Nor, is it necessarily a good thing if house prices rise sharply on the basis of very thin supply.