Old favourites still worth a look

National Savings is set to hit its 30 million investors over the next two weeks with further interest rate drops on some of its key products.

The Government savings bank will take a knife to its Ordinary Account and Income Bonds in response to the recent cuts in interest rates by the Bank of England.

The current Ordinary Account interest rate of 1.75 per cent on accounts with less than ?500 will fall to 1.25 per cent from March 1, while the rate for accounts containing more than ?500 will drop from 2 per cent to 1.5 per cent.

From March 13, Income Bond rates will fall by nearly one-tenth. For accounts with less than ?25,000 the interest rate will decline from 5.75 per cent to 5.25, while those holding more than ?25,000 will drop from 6 per cent to 5.5 per cent.

National Savings has seen its rates tumble by more than a third since May last year. According to critics, the severity of the cuts has left most of its products vulnerable to mass defections at a time of acute competition in the savings market.

New entrants like Standard Life Bank and the Prudential's Egg banking arm are offering rates that match or beat the current 5.5 per cent base rate, leaving the traditional providers standing. Egg is offering an account with almost instant access a full point above base rate, with a guarantee it will stay half a per cent above the base rate until spring next year. That puts the Egg rate of 6.5 per cent rate ahead of the Ordinary Account rate by 5.25 per cent.

Most other savings rates on easy-access accounts have fallen to historically low levels, with many dropping below the 1 per cent mark. And like them, National Savings is likely to be suffering a loss of business to the more aggressive new entrants.

Despite a ?10 million marketing campaign with a large advertising agency, the shifts in the market show how difficult it will be for the organisation to throw off its old-fashioned image, dating back to 1861 and the days of William Gladstone and the first shots in the American Civil War.

A spokeswoman for National Savings, Clare Staley, argues that savers should beware the lure of the best offers in the same way that ancient Trojans should have been wary of Greeks bearing gifts. "They are out there aggressively trying to buy new business. They want to grab as much of the market with loss-leading rates, but there is no guarantee how they will play it after next year when the commitments to stay above base rates on products like Egg run out."

Of course, this argument doesn't really work in relation to a National Savings Ordinary Account. Ms Staley is relying on the organisation's higher rated certificates to rival Egg and others.

"People have the choice of going for the high variable-rate products or our fixed and index-linked rates that could mean they are laughing if interest rates and/or inflation go up again. People are uncertain what is happening to rates, and though we don't offer advice, rates look like they are coming down and it might be wise to tie up your money now."

Even with the new rates for Income Bonds with a 90-day notice period of withdrawals, the National Savings rates beat the likes of Abbey National's Investor 90 at 3.88 per cent, Bradford & Bingley's Special Asset at 3.49 per cent and the Portman Building Society at 4.75 per cent.

But the nearest National Savings gets to the new entrants is with its index-linked savings certificate which pays a guaranteed 1.65 per cent above the inflation rate free of tax. Currently that works out at an equivalent of 5.19 per cent for lower rate taxpayers and 6.92 per cent for higher rate taxpayers.

Simon Philip, a partner at accountant Arthur Andersen who specialises in personal financial planning, says higher rate taxpayers could do well out of the index-linked certificate, but says to tie savings up for five years is a high price to pay for decent rates.

"Five years is an incredibly long time in investment terms. There is so much that can happen in that time and quite frankly there are plenty of other products out there that can generate higher returns."

He says the idea that savers could be protected by falls in interest rates and rises in inflation is flawed. He is not convinced either is likely to change dramatically. "And even if they do I would rather wait and see."

Justin Modray, of financial advisers Chase De Vere, agrees that even the most conservative savers can hunt for better rates without too much trouble. "National Savings products are not a rip-off like some savings accounts out there, but it doesn't take much shopping around to find better deals."

Mr Philip denies that savers will need to take excessive risks to beat the National Savings rates over the long term. He recommends the increasingly popular income shares from investment trusts to higher rate taxpayers in search of the best returns. "The gains can go against capital gains tax allowances, which most higher rate taxpayers don't use up," he says.

National Savings also offers an Investment Account with a sliding scale of interest rates. Deposits of less than ?500 qualify for a rate of 3.95 per cent working up to a top rate of 5.25 per cent for deposits of more than ?50,000.

For the young and old there are Children's Bonus Bonds (Issue M) and Pensioner's Bonds, both offering 4.25 per cent.