When cash is not always king - inflation and the impact on savings

After many years of low interest rates, savings rates have made a significant comeback over the last few years. UK interest rates generally increased, reaching a peak in early 2023 before experiencing a decline in late 2024 and early 2025.

The Bank of England began raising interest rates in late 2021 to combat inflation. This resulted in a sharp increase from 0.1% in December 2021 to 5.25% in August 2023. The current base rate is 4.25% (June 2025).

Inflation continues to exceed the 2% target and commentors anticipate it to persist at similar levels throughout the year. Consequently, monetary policy is likely to remain tighter, with higher interest rates, than previously expected.

How does a changing interest rate impact savings?

A falling base rate is likely to see a reduction in the returns offered to savers by banks and building societies. Any cut could particularly affect those who take the interest from savings to top up their income.

Considering economic turmoil in recent years, caused by trade wars, the Coronavirus pandemic, and Liz Truss’s 2022 “Mini-Budget”, some savers have sought safe havens for their money. In times of trouble, cash is traditionally seen as offering capital security over other assets such as shares, fixed interest, and property.

Risks to holding high levels of cash

However, savers still need to apply caution. Even in 'normal' times, some people hold high cash balances, perhaps to meet capital expenditure in the short term or just to provide extra peace of mind, but there are unseen risks - namely inflation, which reduces the purchasing power of each pound held.

There is also another risk to holding cash. There are limits to the amount of protection provided when holding cash for all other deposit providers, bar the Treasury backed NS&I. The Financial Services Compensation Scheme (FSCS) offers individual account holders protection up to £85,000 (£170,000 joint account) if their banking/building society or credit union is unable to meet its obligations to investors – however, additional care is needed, as this is restricted where you save across various accounts within the same banking group (where they have a shared banking licence).

Finally, holding cash in savings accounts can attract tax on the interest. Basic-rate taxpayers can earn £1,000 a year in interest tax-free, while higher-rate taxpayers can earn £500 tax-free. It is important to make use of tax wrappers that mean you don’t attract unnecessary tax on the interest.

What can you do with your hard-earned savings?

Armstrong Watson offers a cash management service that could help improve the overall interest your savings earn for you and can keep you within the FSCS compensation limit.

Cash itself is not risk-free. Although the capital may be secure, it is easy to overlook the power of inflation, which erodes the value of savings. Investing in cash may lead to financial disappointment; although it hasn’t been the case for the last 20 months or so, historical trends show savings rates tend to be lower than inflation, meaning prices rise faster than the value of your savings.

Everyone should have an emergency cash reserve to pay for unexpected bills, classed as short-term savings. However, for capital you don’t need access to in the foreseeable future, it may be time to consider whether alternative options, which aim to achieve a better return ahead of inflation, may be suitable.

Our Introduction To Investing aims to help you understand, whatever your knowledge and experience, the principles of saving via bank deposits to investing. The intention being to help you to make informed decisions.