Investor thirst may not be quenched by NS&I return

When National Savings & Investments (NS&I) relaunches its index-linked savings certificates this summer, the demand is likely to be unprecedented. But the returns paid by the NS&I product and by the raft of inflation- beating savings accounts launched in recent weeks will leave savers disappointed, it has been claimed.

The certificates were withdrawn last year to prevent NS&I from gaining an unfair advantage over banks and building societies. About 5.4 billion was invested in them in the three months leading to their withdrawal last July, as savers sought shelter from rising inflation. Demand was also driven by the paucity of returns available on savings accounts, a situation that has only worsened.

The Chancellor revealed in last month's Budget that the popular certificates would be reintroduced as part of a 2bn increase in the "net financing target" for the government-backed savings provider.

The appeal of the certificates will be boosted considerably by their continued link with the retail prices index (RPI), typically a higher measure of inflation than the consumer prices index (CPI) measure. The government is in the process of adopting the lower measure for its calculation of a wide range of benefits and allowances, from state and public sector pensions to national insurance and capital gains tax thresholds, a manoeuvre set to cost millions dearly.

While the certificates will pay out RPI plus 1 per cent, it seems they are unlikely to be available until the summer. A spokesperson for NS&I said it was still unable to confirm exactly when the certificates will be back on sale.

"What we can confirm at this stage is that they will continue to be RPI index-linked and their tax status will remain the same. We are reviewing all other aspects currently," she added.

NS&I wants to avoid having to pull the products from sale again, which is believed to be the reason for the delay in their reintroduction. However, the certificates are expected to prove as popular as ever, with inflation unlikely to fall significantly for several months and few savings account offering protection against inflation. It was revealed yesterday that CPI and RPI fell to 4 and 5.3 per cent respectively last month, but they are expected to remain high for some months to come.

The NS&I certificates are three and five-year bonds that promise a tax-free return of 1 per cent above RPI and you can invest between 100 and 15,000 in them. That means that at the current 5.3 per cent rate of RPI, they offer a tax-free return of 6.3 per cent, well above that offered on other savings products.

But in practice it isn't that simple. The RPI element of the return is based on the RPI reading at the start and end of each investment year only.So if you were to take out an NS&I inflation-linked bond this week (had they been available), the return for the first year would be the difference between the "strike" rate (the rate when it is taken out) and the rate next April. If the difference is negative, then RPI isn't factored in. If it's positive, it is added to the anniversary interest rate.

That means the value of the products really depends on what happens to interest rates and inflation. If inflation were to remain high and interest rates low, then the returns would be attractive relative to other products. But they will be less impressive if inflation falls and interest rates rise - and both seem certain to happen over the coming years.

The chances of inflation remaining at the current level or above over the next three years are slim. Most experts expect it to fall later this year and hover around the 2.5 to 3 per cent mark next year. Adam Posen, a member of the Bank of England's monetary policy committee, believes it will fall to 1.5 per cent by mid-2012, while the Office of Budget Responsibility forecasts inflation at 2 per cent by 2013.

Kevin Mountford, head of banking at Moneysupermarket.com, said: "If inflation drops over the three or five years of the term, the end return might not be as good as that available from other products on the market at the time. It will take some doing to get a decent return."

The NS&I product will be popular, particularly as it is tax-free and guaranteed by the government, he added. "But, as with everything else, you need to go into it with your eyes wide open. Don't be seduced by the marketing blurb."

There is already a handful of inflation-linked products on the market (or set to launch), although most are taxable. (See box for more details). But their value depends on the level of inflation at the outset. If it is high - and likely to fall during the term - the scope for growth is significantly reduced.

Michelle Slade, at Moneyfacts, said: "Many of these account don't apply the level of RPI until next year, when the likelihood is that it will be lower than the current level. All of these accounts require a medium to long-term commitment, without access during the term. If inflation is brought down quickly and remains low during the term, then the returns will be low. If inflation remains high for a significant period these accounts could offer a competitive return," said Slade.