Five Questions About: Beating inflation with savings

How does inflation affect my savings?

Inflation rose to 4 per cent in January, up from 3.7 per cent in December. During 2010, a saver with £10,000 in an average savings account would have effectively seen their savings eroded by £331.

How much do I need to earn to offset inflation?

A basic-rate taxpayer will now need to earn at least 5 per cent on savings; higher-rate taxpayers need an even better rate. That's a tough call when base rate remains at 0.5 per cent. Savers can secure rates as high as 4.75 per cent by agreeing to lock their money in fixed-rate bonds, but if interest rates start to rise there's a danger that these bonds would become uncompetitive.

Will inflation fall soon?

There's no sign that inflation is likely to fall any time soon. In fact, Bank of England Governor Mervyn King has suggested that it's likely to rise even further and could remain above target for the next two to three years. That could mean some relief for savers. High inflation increases the pressure on the Bank to hike the base rate, which would see interest rates move upwards as well.

Will an ISA protect my money?

The best rate available now on an easy-access cash ISA is 2.90 per cent. It is possible to secure a better rate by putting your money in a fixed-rate bond. Another option is a stocks and shares ISA. Returns tend to be higher than with cash accounts, but so are the risks.

Are there any inflation-linked savings accounts?

Birmingham Midshires is offering a five-year bond pegged to the Retail Prices Index measure of inflation, plus 0.25 per cent. If inflation remains high for five years this could be a great deal. But once you factor in tax, most savers will still earn less than inflation.