How to be ready for inflation and interest rates plunging

Inflation is still in double digits and the cost-of-living crisis is putting untold pressure on household budgets, but here's the good news. It's not going to last much longer.

Consumer price growth will fall to just 2.9% by the end of the year, according to the Office for Budget Responsibility. The trend will continue with inflation sliding to just 1% by 2025, the Bank of England says, then 0.4% in 2026. That’s a dramatic reversal and it's going to have a huge impact on today's savings and mortgage rates, so get ready.

Prices have been driven up by a range of factors, including the energy shock, post-COVID supply chain problems and years of easy money and stimulus.

Now those trends are going into reverse as interest rates rise and last year’s monthly spikes fall out of the annual figures. This will be good news for homeowners but may prove a blow for savers.

With interest rates set to fall, now could be a good time to secure a long term fixed-rate bond

After years of getting almost no interest on their cash deposits, savers were suddenly spoilt for choice last year. By October, challenger bank United Trust Bank paid a fixed rate of 5.05% on its five-year bond. Sadly, nobody pays that now.

Today’s best buy five-year bonds pay around 4.5% and that’s likely to decline as banks anticipate a sharp drop in interest rates. The Bank of England’s base rate is currently 4.25% but that will fall to 3% next year and just 2.5% in 2025, according to forecaster Capital Economics.

Banks don’t want to pay 5% for five years when interest rates are likely to be far lower, says Anna Bowes, founder of savings-rate tracking service Savings Champion. "Now might be a good time to lock into a long-term fixed rate because this may be as good as it gets”.

Today, savers can get market-leading rates of up to 3.5% with instant access, but Bowes says tread carefully. “In contrast to a fixed-rate bond, these can be cut at any time.”

There is one consolation for savers, though. Even savers who were getting 4% or 5% on cash were seeing its real value eroded in real terms, with inflation at 10%. It won't do as much damage in future. With mortgages, these assumptions all go into reverse.

Taking a variable mortgage rate could let you take advantage of interest rate falls later on

Last autumn, in the wake of former chancellor Kwasi Kwarteng's disastrous mini-Budget, mortgage rates rocketed past 6.5%. Terrified borrowers with fixed-rate mortgages faced paying hundreds of pounds in extra interest every month once their deals expired. Yet, best buy mortgages have now dipped below 4% and will fall further as near the first Bank of England interest rate cut.

Homeowners should think twice before locking into a long-term fixed-rate mortgage today, says David Hollingworth at brokers L&C. "It may be better to take out a variable rate deal, then take advantage of any interest rate falls in a year or two”.

It's a tricky decision, Hollingworth says, as future rate movements are hard to predict. “If you’re at full stretch, a fixed rate will give you peace of mind”.

We are about to enter a new world as inflation falls. However, whether you’re a saver or a borrower, the old rule applies. Always shop around to get the best deal for you.

Read more: 20 ways to beat the cost-of-living crisis

Read more: How to make the most out of your savings

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