High demand forces National Savings to be less generous

Savers have been dealt another blow after the decision by National Savings and Investments (NS&I) to pull its inflation-beating savings products, blaming high levels of demand.

The fixed interest and index-linked savings certificates were withdrawn and rates on the direct saver and income bonds were reduced by 0.25 percentage points after an influx of funds left NS&I too close to its cash target, set by the Government, aiming to balance the money coming into NS&I with the money coming out within a range of £2bn either side.

This time last year, the net financing figure was minus £1bn and the NS&I introduced more appealing products to boost sales, but the first-quarter results of this year paint an altogether different picture.

It was decided that the popular index-linked and fixed-interest savings certificates would be the casualties. Jane Platt, NS&I's chief executive, says this is a fairer approach to the 1.3 million who have already invested in these products. "We could have made more interest rate cuts but we decided it was fairer to customers to withdraw these products which had much higher sales than we expected," she says.

The most recent issues of NS&I's fixed interest certificates offered a tax-free return on investments up to £15,000 of 1.25 per cent on a two-year bond and 2.25 per cent on a five-year bond. A much bigger loss to savers, however, is the index-linked certificates, which were available in three and five-year terms, and offered a guaranteed tax-free return of retail prices index (RPI) plus 1 per cent.

One glimmer of hope is that Ms Platt has said that they are still part of the NS&I product range and will at some stage make a reappearance. But in the meantime, these moves will seem like a kick in the teeth for savers looking for a safe haven for their funds and protection from higher than expected levels of inflation.

"The question is when will NS&I reintroduce these certificates. I suspect not for some time. NS&I might also take the opportunity to re-peg index-linked certificates to the consumer price index (CPI) rather than RPI when they are relaunched. This is generally lower than RPI meaning future index-linked certificates would be a worse deal for the investor and cheaper for the Treasury," says Danny Cox from Hargreaves Lansdown, an independent financial adviser.

With interest rates so pitiful and the RPI at about 5 per cent, it is no surprise that the NS&I index-linked certificates were winning savers over. As an added incentive, it has the backing of the Government and customers are safe in the knowledge that 100 per cent of their money is protected.

NS&I hit the headlines last year when it launched a one-year bond paying 3.95 per cent. This beat any other offer in the marketplace by 0.25 percentage points and had to be pulled after just 24 days amid accusations from commercial banks and building societies that the group was ruining their chances of attracting savers' cash. NS&I's decision to axe its more competitive products, therefore, will be a welcome move for its competitors.

"Although it's bad news for Joe Public, banks and building societies will be rubbing their hands to see these products withdrawn and rates cut as they'll benefit in the form of a bigger slice of savings business," says Andrew Hagger of Moneynet.co.uk.

Existing customers of these savings certificates will also be breathing a sigh of relief that they made it in time as they can keep their money invested and reinvest it when their account matures. New customers, however, who are already struggling to find savings products that can beat inflation will have even fewer options.

Index-linked gilts, or government bonds, are an alternative and offer a return linked to RPI and are free from capital gains tax, but these are traded on the stock market. A better strategy may be to wait to see what NS&I comes up with when it reintroduces a new inflation-linked savings certificate, and to concentrate on the best conventional deposit accounts.

"More than ever, people should be looking at their existing rates and, first and foremost, making the most of their individual savings account (ISA) allowance so that they can earn interest at gross rate," says Kevin Mountford from Moneysupermarket.com.

Santander's Super Flexible ISA offers an impressive return of 5.5 per cent but only to customers taking out a separate investment product with the bank. Elsewhere, Nationwide's three-year fixed-rate ISA pays 4 per cent and Nationwide's e-ISA pays 2.75 per cent, followed by the AA, Birmingham Midshires and Cheltenham & Gloucester, all paying 2.70 per cent. However these still leave savers vulnerable to the CPI (which doesn't take into account housing costs) which is running at 3.2 per cent. A basic-rate taxpayer will need a return of at least 4 per cent to beat this.

Only bonds of at least three years fit the bill, such as the best buy fixed rate account from Bank of Baroda UK which pays 4.30 per cent, or ICICI Bank's 4.75 per cent for savers willing to lock £1,000 away for five years.

Savers may prefer to look at more innovative accounts, such as the new three-year stepped rate bond from RBS which pays 2 per cent in year one but increases to 4 per cent in year two and a more appealing 6 per cent in year three. Otherwise, only regular savers are offering returns of 5 per cent, such as the Norwich & Peterborough Family Regular Saver and Nottingham building society's fixed rate saver, although these are restricted to a maximum monthly deposit of £250 and £100 respectively, which compares unfavourably to the compound effect of investing a lump sum.

"Thankfully this is a competitive market and people still have a lot of choice. There are some good rates available and the £50,000 compensation schemes in place are enough to protect most people's savings," says Mr Mountford.

Expert View

Andrew Hagger, Moneynet

The decision to withdraw the index-linked savings certificates from sale is another blow to savers who are becoming increasingly fed up with low interest rates and are seeking an alternative home for their money.

There are better returns to be found on long-term fixed-rate bonds with rates of up to 4.75 per cent available for a five-year term. However, tying your funds up without access for long periods will not be the ideal scenario for some people.