What does sticky inflation mean for interest rates?

Although a small rise in inflation had been expected in the 12 months to July 2025, the latest figures still came as a surprise. The cost of living increased to 3.8 per cent, up from 3.6 per cent in June - higher than forecast and the fastest annual pace since January 2024. For savers and borrowers and policymakers alike, the news complicates the outlook for interest rates. 

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Why has inflation risen? 

The biggest hike was airfares, which surged by more than 30 per cent in July - the steepest increase ever recorded for this time of year. The timing of the school holidays played a part: in 2025 term ended earlier, prompting many families to book at once, driving prices higher. A year earlier, with the school term running later into July, demand was weaker and fares stayed lower.

However, food prices added to the pressure for many. Annual food inflation rose to 4.9 per cent, with items such as beef, chocolate, coffee and orange juice all more expensive. For households already grappling with tight budgets, increases in everyday essentials are particularly hard, as they can’t be avoided. 

Energy and transport costs crept higher too. Petrol and diesel prices edged up, erasing the relief that falling motor fuel costs provided earlier in the year. 

Finally, services inflation remained stubborn, rising to 5%. Hotels and restaurants led the way, although many have suggested that the Oasis reunion tour temporarily boosted this – echoing last year’s “Taylor Swift effect”. Whilst one-off cultural events can distort the figures, the broader picture is clear: underlying price pressures remain sticky, and certainly higher than the Bank of England would like. 

Implications for interest rates 

The outlook is now even more uncertain. 

On the 7th August, the Bank of England’s Monetary Policy Committee (MPC) voted to cut the base rate from 4.25% to 4% - the third cut this year. Whilst this has seen savings rates start to fall, especially variable ones, the higher-than-expected inflation figures could slow the pace of further cuts. 

It is now unlikely that the Bank of England will cut rates again this year as was previously expected, with markets expecting reductions to be pushed back into 2026. This is bad news for mortgage holders but offers some respite for savers, as rates should not tumble as quickly as feared. 

What is happening to savings accounts? 

In the weeks leading up to August, the easy access best-buy tables had remained pretty static, but the base rate cut broke that deadlock, triggering a number of reductions. Chase remains the market leader with its ‘Saver account with boosted rate’ at 4.75 per cent AER, although this has been reduced from 5% – for both new and existing customers - and is available only to new current account customers. 

Several other providers have withdrawn or cut their rates. Atom Bank, for example, slashed its Reward Saver by 0.6%, a huge cut especially when it will affect both new and old customers, and knocking it out of our top five. Cahoot relaunched its popular Simple Saver at a lower level too, although it remains the top unrestricted easy access account paying 4.40% AER. 

Check out our Best Buy tables for the current top rates available.

A similar story has played out in the easy access ISA market. Plum, which had been paying 4.86% a month ago, still leads but new customers now receive a lower rate of 4.41%. 

Fixed-rate bonds have been more resilient. Shorter-term deals, such as one-year bonds, have slipped slightly, but longer terms have held up well. In fact, five-year accounts are now paying marginally more than a month ago, showing that banks are once again willing to reward savers prepared to commit for the longer haul. 

Fixed-rate cash ISAs tell a similar, if not slightly better story. Unlike with the fixed rate bonds, top one-year rates are a touch higher than they were in July, and two, three and five-year best rates have increased marginally too, suggesting that fixed accounts, including longer terms, may continue to provide a haven for savers looking for certainty. 

What should savers do? 

With some savings rates slipping or, at best, holding steady, whilst inflation is rising, this means fewer inflation-beating accounts are available, particularly for taxpayers already making full use of their Personal Savings and ISA allowances. To keep up with inflation at 3.8%, a basic-rate taxpayer needs a gross return of 4.75% on a taxable account, while a higher-rate taxpayer would need 6.33% – an impossible task in the current market. 

Even so, shopping around makes a substantial difference. Barclays, for example, is now paying just 1.11% on its Everyday Saver account. A basic-rate taxpayer with £50,000 in this account would take home a net return of less than one per cent - 0.89%. Compare that with a competitive account paying around 4.5% (before the deduction of tax): after tax, the basic-rate saver would take home 3.6% and the higher-rate saver 2.7%. Although neither beats inflation, both are far better than the paltry return from Barclays. 

And the effect on purchasing power is clear. With inflation at 3.8%, £50,000 left in the Barclays’ account for a year would grow to £50,445 after basic rate interest has been accounted for, but its real value would shrink to £48,589 once inflation is taken into account. The same sum in a 4.5% account (3.60% after tax) would grow to £51,800 after tax, but more importantly leaving a real value of £49,904. Choosing the wrong account could therefore reduce purchasing power by more than £1,300 in a single year. 

Take a look at our inflation calculator to see how your cash savings are holding up.

Given these figures, savers are likely to increasingly turn back to NS&I Premium Bonds. Winnings are tax-free, and a return equivalent to the current prize fund rate of 3.60% translates into 4.5% for basic-rate taxpayers, 6% for higher-rate, and 6.55% for additional-rate. 

No savings accounts currently offer these rates for higher and additional taxpayers, except accounts that pay higher interest on very low balances such as the Santander Edge Saver which pays 6% gross on up to £4,000, but is only available for Santander Edge Current Account customers. 

Of course Premium Bonds carry the risk of winning less than the average rate – or even nothing, although larger holdings usually generate at least some prizes. 

The key message is to stay vigilant. For savers, higher inflation means that they must balance the possible erosion of real returns against the need for accessible cash. But, by shopping around and resisting the temptation to leave money languishing in poorly paying accounts, savers can at least mitigate the damage and preserve more of their purchasing power. 

If you are concerned about how inflation may be affecting your savings and investments, why not get in touch and see if we can help. For all those with £100,000 or more in savings, pensions, or investments we are currently offering a free review worth £500. You can request a free non-committal initial consultation with a member of our team or give us a call on 033 323 9065 to get in touch.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The accounts and rates mentioned in this article are accurate and correct as at 26/08/2025.

The Financial Conduct Authority (FCA) does not regulate cash advice.