Why Interest Rates Are Soaring (But Not for Savings Accounts)

Across the world, interest rates have skyrocketed, with banks increasing the cost of borrowing all over the globe. 

This means that getting – and paying off – mortgages, credit cards and many other types of loans is more expensive.

In an attempt to slow down the rate of inflation, which is the highest it’s been in decades, dozens of countries – including the US, UK, South Korea, India and numerous European states – have increased interest rates in the hopes of slowing down price increases on everything from groceries to utilities.

Why have interest rates increased?

Raising interest rates is thought to slow down the economy and suppress the rate of inflation, which is currently making the price of consumer goods soar. 

The rationale behind this is that raising interest makes it more expensive to borrow money and discourages borrowing due to the inflated cost of doing so. Not only does this tighten consumers’ purse strings, but it also prevents businesses from expanding too quickly, contributing to the inflated prices of goods.

These inflated prices result from an array of factors, including high demand, lower-than-average supply, the rising cost of energy and the lingering financial consequences of the pandemic, among others.

On the reverse, raising interest rates is meant to encourage saving since – in the past – this has usually meant that interest rates associated with savings accounts have also increased.

These two effects should, in theory, reduce what people are willing to spend on goods, and they resultantly buy less. Subsequently, this slows down the growth of businesses as they make fewer sales and are encouraged to drop – or deflate – prices to entice customers into buying.

Thereby, the rising price of goods is slowed, and inflation should be reduced.

Why haven’t interest rates risen for savings accounts?

As we’ve mentioned, typically, raising interest rates means that loans offered by banks cost more, making borrowing more expensive. 

This usually coincides with banks raising the interest offered on savings accounts to encourage saving and discourage excessive purchasing of goods. However, in the case of most savings accounts currently, this isn’t the case.

In general, the interest rates of savings accounts are determined by how desperate banks are to attract customers to receive their deposits and provide them with lending power.

This lending power is obtained as a result of the capital deposited by customers of that bank, which can be loaned to other customers, allowing them to make money from the interest paid on those loans subsequently.

As can be surmised from the staggeringly low-interest rates offered by many banks on their savings accounts, many traditional banks feel they have deposits worth a high enough value to cover their lending needs and don’t need to entice new customers to open savings accounts with them.

As such, the interest rate associated with many savings accounts has remained low despite the rising interest rates of everything else.

Is the rate of interest increase on savings accounts likely to increase?

Although many banks offer very poor interest rates on their savings accounts – especially considering inflation and the rising cost of borrowing – some offer the highest interest rates in decades.

In particular, smaller and/or online banks, some of whom are offering around a 3% interest rate on deposits held in savings accounts by their customers.

While this is still significantly lower than the rate of inflation and the overall increase in interest rates – it’s a significant boost compared to the 0.01% offered by many traditional banks and could help consumers earn hundreds more per year by simply switching banks.

What’s more, if many more people began to switch to banks offering higher-interest savings accounts, it would force bigger banks to make the interest rates on their savings accounts more appealing to remain competitive. 

Otherwise, they won’t have enough capital to fulfil their lending needs.

Why don’t banking customers switch to higher-interest savings accounts?

As we touched on briefly, if customers choose to open savings accounts with banks that offer higher interest rates, the average person could earn hundreds more per year in interest (while the wealthier could even earn thousands).

However, many overestimate the time and effort it takes to switch accounts and fail to realise how much they could earn each year by simply shopping around for high-interest savings accounts and making the switch.

So, if you want to make the most of the current economic climate, it’s worth comparing savings accounts between banks to increase what you earn through interest each year and maximise the value of your savings.