What do NS&I rate cuts mean for the savings market

21/09/2020

This wasn’t a shock in itself as the Income Bonds, Direct Saver and Direct ISA all sat at the top of the best buy tables.  It was only a matter of time before they had to either decrease rates or announce an increase in their net financing target (the amount HM Treasury ask them to raise each year), because inflows were so strong as a result.  What did surprise was just how savage the cuts are going to be.

The following changes to NS&I rates come into effect from 24^th November 2020:

The Premium Bond prize fund will also be reduced to 1% (from 1.40%) at the same time.

How did we get to this point? 

17^th February 2020 - NS&I announced rate cuts to come into effect from 1^st May.  This was to cut the rates to reduce inflows.  Interest rates in the wider market were falling and NS&I was sensibly following suit. 

11^th March - NS&I announced a net financing target of £6bn for 2020-2021 financial year (which for NS&I runs from 1^st April to 31^st March), with a range of between £3bn and £9bn. 

17^th April – NS&I announced that the rate cut will be pulled, and rates will remain unchanged to support savers during the coronavirus.

16^th July – with interest rates in the wider savings market collapsing, and NS&I sitting top of best buy tables, an increase in net funding to £35bn (£32bn - £38bn range) was announced as part of its first quarter results, which showed net financing already at £14.5bn

With monthly Premium Bond winners announcements in August and September detailing the prize fund, it was clear that NS&I was seeing ever stronger inflows and that they were fast reaching their net financing target and would have to act.

How will this impact the savings market?

NS&I’s Q1 results show total savings balances of £193.7bn and its latest Premium Bonds draw shows £110.2n in the prize pot – so roughly 56% of NS&Is balances sit in Premium Bonds.

Q1 inflows were £14.5bn.  Given that its Q2 saw rates in the wider market fall further, I suspect NS&I has seen stronger inflows in this quarter.  I expect to see it announce net funding of circa £32bn in its Q2 announcement in mid-October i.e. it will be close to the lower end of its annual target already, at its half year point.

Therefore, today’s rate cuts need to both stem inflows and, given their will be a lag in their impact, probably trigger some outflows.

Premium Bonds will still look attractive, even at the new lower 1% rate, with most of the leading providers in the easy access market paying around 0.80%.  I expect the strong inflows to Premium Bonds to cease but don’t predict widespread outflows.  Overall, I think the prize fund will stabilise.

However, the same cannot be said for Income Bonds, Direct Saver and Direct Saver ISA which will all be towards or at the bottom of the market pricing wise.  With over £44bn in these at the end of NS&I’s 2019 financial year, accounting for circa 25% of the book, there is likely somewhere north of £50bn in those accounts now.

If just 20% of that moved, it’s the equivalent of what Aldermore, the largest new entrant savings provider without branches, has acquired in savings balances in over a decade.  Given that a typical new entrant challenger bank will be looking at raising £25m – 50m a month, even just a very small percentage of those balances moving is likely to flood the market, which will force pricing down.

However, to cut to just 0.01% on Income Bonds in particular, is so savage that I think outflows could be much stronger.  The initial reaction from NS&I customers is one of fury.  Clearly many expected cuts but not the severity of them.  I think we could see as much as half that money move.  £25bn of extra liquidity in the market could only put downward pressure on rates.

Are further interest rate cuts in the market inevitable?

I think they are.  Even if we some of the new banks which are authorised but not live in the savings market (e.g. Castle Trust), or authorised with restrictions (e.g. Oxbury, JN Bank and Vive), launch, they are unlikely to have the capacity to absorb such volumes and halt the price cuts. 

Perversely, the best hope for savers who shop around for good rates, is that much of the money leaves NS&I and returns to the big current account providers instead of going out into the best buy tables.  If this happen, it could cushion rate falls.

However, I think we will start to see NS&I money move out from October and the interest rate bounce we have seen since late July, will be short lived.  I anticipate we will see rate falls in the wider market through the back end of the year with things.  The only positive is that I think that the money will move over a very short period of time.  Therefore, falls may be concentrated through late October to December with the market recovering again in January, as providers re-enter the market with new targets for 2021.

My advice to savers is to take the best rates now, while they are still there.  1 Year Fixed Rate Bonds currently offer the best value with 1.30% being paid which is significantly clear of the best buy rates once NS&I goes, and only 0.20% less than the best 5 Year rates.