As interest rates continue to fall in the United Kingdom, Cash ISA rates are beginning to fall closer to the rate of inflation, increasing the risk of real-term losses for savers.
Recent forecasts have suggested that the Bank of England is likely to cut interest rates in December and again in Q1 2026, in a move that would see the base rate cut to 3.50% in the new year.
Expectations are high for these cuts, with nearly 80% of economists expecting the initial 25 basis points reduction to take place on the 18th of December. But what does this mean for the nation’s savers?
Government data shows that as many as 9.94 million UK residents subscribed to Cash ISAs in the 2023/24 tax year, representing a seven-year high for savers. But with the Cash Individual Savings Account’s rates intrinsically linked to the Bank of England’s base rate for interest, could there be a risk that Cash ISAs eventually fail to provide returns that outpace inflation rates?
Rate cuts mean good news
If you’re a Cash ISA holder, don’t panic. The most important thing to keep in mind as interest rates fall is that they often happen as a result of good news. In the case of the prospective cuts in the weeks and months ahead, the good news is that inflation appears to be falling.
Optimism is growing for interest rate cuts because October’s inflation data eased from 3.8% to 3.6%, setting the United Kingdom on a downward trajectory that will ease the pressure on the economy.
Although these figures put inflation at a higher rate than the expected interest rate of 3.5% by early next year, the Bank of England’s latest forecasts claim that the rate of inflation is on track to fall to its 2% target by 2027.
When it comes to ISAs, the aim of the game is to make a tax-efficient boost your wealth, that’s ideally beyond the rate of inflation. If your returns are weaker than inflation, you’re making a loss in real terms because your money is devalued by the rising cost of living.
However, falling interest rates generally point to high expectations of a falling inflation environment, and this is the case when looking to upcoming cuts.
Have cash ISAs always beaten inflation?
No. In fact, it wasn’t until the Bank of England hiked interest rates to a peak of 5.25% in August 2023 that interest rates began to outpace inflation in the 2020s.
Historical data from Moneyfacts shows that inflation has consistently climbed above the average savings rate in the UK (with calculations based on the average gross rate on a £10,000 deposit of all on-sale, core market, variable, and fixed-rate savings accounts and Cash ISAs).
Since 2012, the average savings rate has surpassed inflation between 2014 and 2016 before approaching parity in the months following the pandemic, meaning that many savers could be struggling to build their wealth in real terms.
According to Unbiased data, the average 10-year return on a Cash ISA is currently 1.21%, while the Bank of England’s Inflation Calculator places the average rate of inflation over the past 10 years at 3.14%.
However, it’s also worth noting that the past decade has seen a period of historically high inflation that has prompted a significant increase in the cost of living. Current forecasts by the Bank of England suggest that interest rates will remain higher than inflation over the foreseeable future.
Should I keep my cash ISA?
If you’re concerned about inflation eating into your Cash ISA returns, it may be worth looking at a Stocks and Shares ISA, which isn’t linked to the Bank of England’s base rate of interest and instead works as a stock market portfolio to allow you to invest in a tax-efficient way.
However, we’re a nation that’s in love with low-risk investments. In a MoneyWeek survey, 62% of savers said they wouldn’t consider moving their money into a Stocks and Shares ISA if limits were imposed on their Cash ISAs.
For clarity, Cash ISAs remain one of the most effective ways to save money in the UK for short-term savings goals. Their tax efficiency on earnings can provide plenty of advantages when growing your wealth, and the approach is considerably better than simply holding on to your cash in a static bank account.
Stocks and Shares ISAs are a functional alternative for long-term financial goals, and Unbiased data shows that their 10-year returns of 9.64% far surpass the rate of inflation over the same period. But this approach comes with additional risks in investing your money on the stock market.
One alternative could be to buy into an easy-access Cash ISA, which typically offer a variable rate of interest but also allow you to withdraw your holdings at any time. This means that if you’re uncertain about inflation, you could take your money out without becoming stuck in a commitment over a predetermined period.
Managing your ISA
It can be difficult to anticipate the economic environment, but Cash ISAs remain a reliable way to grow your savings in the United Kingdom.
Nobody wants to lose out in real terms on their savings, so making sure you shop around for an ISA that suits your financial goals is essential. Finding the right rates and flexibility for your needs can make all the difference in successful wealth management.
