What's happening to fixed-term savings rates?

Usually when it comes to savings, the longer you lock your money away, the better the return. That rule appears to no longer apply.

A growing number of providers are offering the same rates for a five-year fixed-term account as a one or two-year fix. For example, while the current top rate for a five-year fixed-rate bond is 4.6% AER, the best one-year account is 4.54% - that's a difference of just 0.06 of a percentage point. In fact, interest on a three-year account with Al Rayan Bank is even higher at 4.68%.

It's good news for savers who prefer not to fix for so long, but choosing a longer-term account means your savings will be protected from any fall in interest rates over that period.

Here, Which? takes a closer look at what's currently happening with fixed-term rates and why you shouldn't wait to open a savings account.

A fixed-rate rollercoaster

Savings rates have come a long way in the past 12 months. According to Moneyfacts data from 1 April 2022, the top five-year fixed-term account offered 2.4% AER - now it's more than double that. 

It's not all been smooth sailing though. In the wake of September's controversial mini-Budget, fixed-term savings rates surged, buoyed by predictions that the Bank of England base rate could hit 6% in 2023. 

But after weeks of steady increases, it looked like rates for fixed-term accounts had peaked at around 5% and were even beginning to fall in November. That was driven by an expectation that the base rate would fall later in the year to help the economy cope with the looming recession.

In the third week of February, the tone of the Bank of England’s comments started to change. It was clear that the risks from inflation were far from over and it began to look like we were heading for a period of stagnation rather than recession. The market began to price in more rate rises before the peak, so fixed rates moved up again.

By the time of the base rate announcement in March, the market had largely priced in the 4.25% rate. However, given the fact it came on the back of higher inflation than had been expected, it also raised expectations of rates in the immediate future. As a result, we have once again seen a series of rate rises announced on fixed-term accounts.

This table shows the current top rates for fixed-term savings accounts, ordered by term:

• Find out more: how to find the best savings account

Why are saving rates so similar?

As you can see from the table above, there is very little difference in rates between the various types of fixed-term product. Tying your money up for five years in the current top-rate account will only give you 0.06 of a percentage point more interest than if you invested in a one-year fix.

Why? It all comes down to expectations over future rate rises, says Sarah Coles, senior personal finance analyst at Hargreaves Lansdown. Predictions as to what will happen to the base rate are priced into 'swap rates'. These are how banks exchange a variable rate for a fixed one, with providers hedging their bets against what could happen to interest rates in two, three, five or 10 years. If a swap rate rises, it means the financial experts think interest rates could go up - and vice- versa.

In other words, providers don't want to be stuck paying savers nearly 5% interest over the next few years if it looks like the base rate is going to drop to less than that well before the account matures. 

'At the moment, providers expect rates to rise in the near future to deal with inflation. This is priced into one-year fixed rates, which have been rising,' Coles told Which?. 'Further through 2023 and into 2024, however, the market is more pessimistic about the outlook for the economy, and expects rates to fall again for a significant period in order to support the struggling economy. 

'As a result, the market is expecting rates to be lower for longer – which is priced into longer fixed rates. Banks just aren’t getting a high fixed rate in return for a variable rate over five years on the swaps market, so that’s getting passed on to savers.'

• Find out more: can switching accounts get you better interest rates?

Rates are also dependent on demand

Rates are also determined by how much actual demand there is for a product. Savings providers can decide to offer only a marginally higher rate on longer-term fixed accounts if they feel demand is absent. 

With the base rate expected to rise again when the Bank of England next meets on 11 May, there may be a reluctance among savers to tie their money up in a fixed account now and miss out on potentially higher savings rates to come. That could push rates offered on longer-term products even lower.

Rachel Springall, finance expert at Moneyfactscompare.co.uk, adds: 'While there are other longer-term interest rates to consider, there may well be a dividing sentiment among consumers and providers as to whether interest rates are destined to reduce in the months to come. It will be interesting to see how the top rate deals fluctuate and how demand impacts the shelf life of the best deals over the next quarter.'

How long should you fix for?

Deciding whether to fix for one, two or five years will firstly depend on how long you are happy to lock your money away for. While some providers may allow you to make a withdrawal or close the account in exchange for a fee, others are much stricter and won't allow any access until the term is up.

It will then depend on what direction you think rates will go in the near future. If you want to risk it and hold out for a better deal to come along, remember: in the time you were waiting, if your money is just sitting in a current account, your cash is probably earning little to no interest and so will lose value as it won't be keeping up with inflation. 

Whatever savers decide to do, however, they will still need to act quickly to take advantage of a top rate. That's particularly true if it's offered by a challenger bank that reaches its funding targets, as a deal may only be on the shelf for a short period. We found some high interest accounts are pulled within days of launching.

• Find out more: how to switch your savings account