The Good News Behind Rate Rises

With the Bank of England set to raise its base rate again, we explain why higher interest rates aren't always bad news.

The financial news this week has been dominated by two stories. First, the Consumer Price Index (CPI) measure of inflation hit 3.1% last month. This forced the Governor of the Bank of England to write to Chancellor Gordon Brown to explain why the Bank had breached its upper limit of 3% for CPI. Second, the pound hit a 26-year high against the US dollar, breaching the $2.01 mark.

These two events suggest that the Bank of England is almost certain to raise its base rate again on 10 May, taking it to at least 5.50% a year. This news has been greeted with doom and gloom in most quarters, because it will mean yet more increases in the cost of servicing our £1,310 billion debt mountain.

However, although borrowers on variable rates lose out when interest rates rise, higher rates are welcomed by one particular group of sensible Fools: savers. So, here's a little ray of sunshine for smart savers everywhere -- check out the rates on these beauties:

1. Current accounts

Almost four in five adults have a traditional current account with one of the major high-street banks. One of many problems with these outdated accounts is that they pay almost no interest on credit balances. Indeed, most pay a pathetic 0.1% a year before tax, which comes to £1 a year before tax on a balance of £1,000. Yuk.

On the other hand, by switching to a table-topping current account, you can earn in excess of 6% a year. Here are my picks of the bunch for customers able to pay in £1,000+ a month:

Source: The Motley Fool's current-account search engine

Please note that both of these accounts pay only 0.1% a year on any excess balance over £2,500, so don't leave over £2,500 in them for any length of time.

2. Fixed-rate bonds

Just as interest rates on fixed-rate mortgages have been rising in recent months, so have the rates for fixed-rate savings accounts, also known as 'bond' or 'term' accounts. Indeed, if you have £1,000+ to spare and are willing to stash it away for between one and five years, you can enjoy interest rates which exceed 6% a year. Here are three Best Buys in this category:

Source: The Motley Fool's savings search engine

3. Guaranteed income bonds

Guaranteed income bonds (GIBs) are savings bonds offered by specialist insurance companies. They pay a fixed rate of interest and guarantee to return your capital. Thanks to these guarantees, plus the fact that interest is paid net of basic-rate tax, they are particularly popular with older savers. Here are the latest Best Buys for a lump sum of £20,000:

Source: Baronworth (Investment Services) Limited

4. Index-linked Savings Certificates

Index-linked Savings Certificates are the only savings accounts which are absolutely guaranteed to beat inflation, because they are linked to the Retail Price Index (RPI). For the record, the RPI hit 4.8% last month, which is its highest level since 1991. Thus, the prices of goods and services are rising faster than at any point in the past sixteen years. Ouch.

These Certificates are ultra-safe, because they are provided by the government piggybank, National Savings and Investments (NS&I). This means that they are backed by the 'full faith and credit of the British government'. What's more, they pay tax-free interest, which makes them particularly attractive to higher-rate taxpayers. Here are the two latest issues:

Source: NS&I

So, with the RPI currently at 4.8%, the three-year Certificate pays a tax-free 5.95% a year. For higher-rate taxpayers, this is the equivalent of a gross rate of 9.92% a year before tax, which is hard to beat without risking your capital.

Later this week, in part two of this article, we will reveal the UK's choicest savings accounts, which pay interest rates of as much as 10% a year. Delicious!