Personal Finance: Ernie's more interesting

WHILE interest rates all around are fluttering down like snowflakes, there is one that is caught in an updraught.

Not only is the Premium Bond top prize being quadrupled to pounds 1m to create instant millionaires, but as a result the global interest rate is being raised slightly from 5 to 5.2 per cent tax free.

The way that Premium Bonds work is that the 5.2 per cent earned overall is packaged up into some very large lumps and a few more modest ones, leaving the bulk with nothing at all.

It is not gambling in the pure form practised at the race course or on the National Lottery, because you can always get back the capital sum you invested. You are gambling with the interest.

The other gamble for a long-term investor is that inflation does not erode the real value of the capital.

But in the present climate, with low interest rates and low inflation, it is a fairly low-grade gamble.

The Government, meeting the head-on competition from the National Lottery which will channel cash into particular sports and arts projects rather than the general government coffers, has further improved the attractions of Ernie, the random number system for picking winners.

From February, bonds will enter the draw one clear calendar month after they are bought. Currently there is a three-month delay. As a special offer, all bonds bought in January will be eligible for the first pounds 1m draw in April. And you can get your cash back within two weeks. The moral here is that you might as well invest at the end of the month.

The odds of winning any prize remain at 15,000 to one for every pounds 1 bond every month. So someone holding the maximum pounds 20,000 in premium bonds (and 9,000 of the 23.5 million bondholders have the maximum holding) can expect 16 prizes a year - most of them will be the pounds 50, pounds 100 or pounds 500 prizes that are liberally dished out by Ernie. But as well as the monthly pounds 1m prize there are two pounds 100,000 prizes, three at pounds 50,000, four at pounds 25,000 and 10 at pounds 10,000.

IT WAS clear - I predicted it on 5 December - that National Savings rates would come down following the downward drift of rates. The tax-free five-year certificates now pay 5.4 per cent (down from 5.75 per cent), for instance, and the Childrens Bonus Bond 7.35 per cent (down from 7.85 per cent). The building societies have been waiting with bated breath to see where National Savings was going to pitch the rates.

The general reaction is that the rates have come down far enough not to pose a threat to their own cash flows. But they are still worried about the new 'Granny Bond' that is being launched in the New Year to give the over-65s a fixed income for a five-year period.

The large savers tend to be elderly, and they are naturally highly rate-sensitive as they often rely on savings for their day-to-day living.

At the moment the demand for mortgage finance is pretty thin, so there is no question of building societies not having enough funds in their coffers to meet the demand from home buyers.

But they are on the defensive. Indeed some believe that the recent round of mortgage cuts in the wake of the base rate cut was unnecessary.

The housing market was not being held back by the level of interest rates. And a cut in rates alone is not proving enough to spark it into life. General confidence about job security and economic prospects are now the determining factors.

Even if the banks - which do not rely on high- street savers to the same extent as the building societies - had cut mortgage rates and competed fiercely for mortgage business, the societies might have been able to hold out and serve their more numerous savers the better.

But once one society moves down, all the rest surely follow.