Bill Jamieson: Hard-pressed savers again counting cost of interest-rate cuts

Published on Thursday 8 January 2009 20:59

INTEREST rates are cut to their lowest level in the 300-year history of the Bank of England. But is there dancing in the streets? Is there even a burst of optimism? Neither of these. Never has a rate cut – even one so historic as this – been greeted with less conviction that it will make a difference.

Indeed, rate cuts now look to have run into the Law of Diminishing Returns. And for millions of savers, that law is proving literally true.

Savers are emerging as the real victims of this recession. Not only have hundreds of billions of pounds been wiped off the value of long-term pension funds, but the income these diminished savings will generate has also been slashed to levels that will condemn the most vulnerable households to pensioner penury. Even before the latest cut, the average rate on variable-rate savings has fallen from 4.1 per cent a year ago to 1.29 per cent, according to Moneynet. Several banks and building societies took advantage of the quiet period between Christmas and the New Year to axe fixed-rate offers or reduce the rates paid out on variable savings accounts.

Nationwide, the UK's biggest building society, said it had cut rates across all accounts by an average 0.87 percentage points, but many saw bigger cuts: customers with an internet savings account had their rate slashed by 1.1 percentage points, to just 1.95 per cent.

Savers with 10,000 in an easy access high street bank account have already seen their income fall from 50 a month to less than 25. There are now 210 variable-rate savings accounts paying a mere 0.5 per cent or less – and even lower rates are in prospect after the latest base rate cut.

Gordon Brown may view the latest Bank of England reduction with relief. Will it not, in time, alleviate the plight of mortgage borrowers?

But there is one telling statistic here that should chill him and his advisers to the bone: for every one borrower, there are seven savers. And each saver has a vote.

Interest rates are being further cut in the expectation that this will revive confidence among mortgage borrowers and reignite the housing market. Indeed, most economists see rates falling even further – to 0.5 per cent by the spring.

But what is the reason for believing that further rate reductions will do what the spate of rate cuts over the past six months has singularly failed to achieve? One consequence is for sure: the spending power of those who are dependent on savings to augment their state pension will be further destroyed.

An insignificant economic force, you may think. But look again. Nearly nine million pensioners receive interest income of some sort to supplement their pension. But for the vast majority – eight million – it averages just 51 a week, or 2,500 a year. That income – paid on savings accumulated out of already- taxed income – has now been slashed to pathetic levels.

Earlier this week, David Cameron, the Conservative leader, pledged to abolish tax on the savings income of all basic-rate taxpayers. He also promised to lift personal allowances for pensioners by 2,000 a year. Assuming this survives as a major piece of policy and is not subject to the near weekly re-writing of Conservative positions, this could prove increasingly popular with many who feel ignored in the stampede to cushion borrowers and spenders. They have nothing to lose.

The treatment of savers is all the more callous when you consider that they are being made to pay the price of bailing out the borrowers who got us into this mess in the first place. Those who were prudent, who lived within their means, and who put small amounts aside regularly through the years have now been delivered of a massive kick in the teeth by a panicking central bank that has run out of solutions.

And it puts the government on the spot. There is a growing chorus of criticism that the 12.5 billion cut in VAT has made no discernible difference to consumer spending while pensioners could have been spared the pain of further interest-rate cuts at less than half the cost. It is a point that should not be lost on a government that has elevated unctuous hand-wringing over the plight of pensioners and "hard-working" families into an art form.

According to Treasury figures, pensioners in 2005-6 paid tax on total savings income of 15.6 billion. Allowing pensioners to receive the first 5,000 of investment income tax-free would cost the Treasury, on cautious arithmetic, between 3 billion and 4 billion. And it would take out of tax millions of those pensioners most vulnerable to the slashing of their interest income.

The born-again, instant-cure Keynesians would protest that encouraging savings is the last thing we should be doing, faced as we are with a severe and deepening recession.

But this recession is the direct consequence of a decade-long explosion in household indebtedness. Borrowing surged while savings were run down. Indeed, in the first quarter of last year the UK household savings ratio went negative for the first time ever. A rebalancing is long overdue. And the more that retail savings deposits are rebuilt, the more funds financial institutions will have in due course to lend out to business and home buyers. It is not the cost of money that is the problem, but its availability as wholesale funding has dried up. The revival of retail deposits can greatly help here.

In any event it is absurd to imagine a modern economy functioning without savings: they are absolutely vital for the financing of industry as well as the housing market. Lifting punitive tax barriers to saving will not only help to refinance the economy in due course, but return us to a long-overdue sanity in our financial affairs. Remember: for every borrower there are seven prudent savers who make lending possible. Savers really matter.