Inflation linked savings bonds on the rise

I was going to take a week off writing about inflation – honestly I was.

But no sooner has everyone started fearing inflation, then financial providers have rushed out a slew of inflation linked bonds to shift for fat profits calm their nerves.

Only the other week in my piece on 10 ways to stop inflation, I pointed to the new Birmingham Midshires bond and made this prediction:

Banks and building societies are starting to offer savings products tied to the inflation rate. It’s clever thinking on their part, as the demand is likely to be huge.

I think we’ll see more of these in the next few months […] so keep your eyes peeled if you’ve got cash that you want to safely tuck away for years.

Did I say a few months? I meant a few days.

No really!

Your Inflation Linked Bond is in the post

Okay, even I was surprised to see the Post Office getting straight in on the act with its own inflation bond.

The Post Office inflation linked bond runs for a fixed term from 26 May 2011 to 27 May 2016 – assuming that our robot servants haven’t risen up and taken over our places by then.

Indeed, those five years will feel even longer, given that interest is only paid at maturity.

But here’s the good bit: The bond pays out an interest rate equal to the RPI rate of inflation in April each year, plus 1.5% a year – even if inflation is negative that year.

In other words, you’re guaranteed a real return of 1.5% a year.

With RPI inflation running at 5.1% as I type and the very best cash ISA savings account offering just 3.2% (and most under 3%) it seems an excellent deal.

You can put up to £1,000,000 in, too, so even high rollers among the Monevator faithful won’t have to lose out.

Snags include the fact that no withdrawals are allowed1, that it can’t be held in an ISA as far as I can tell, and that the bond could be yanked at any moment if over-subscribed.

More inflation linked bonds… from Credit Suisse!?

You needn’t go to The Post Office if you want inflation protection. The Yorkshire Building Society has also just launched a very similar five-year inflation linked bond that talks about RPI plus 1.5%. And this one can be held in an ISA.

On the face of it, that’s very attractive. So attractive, the Chelsea Building Society has launched the same product!

However, there are important wrinkles.

Firstly, both these bonds only pay 1.5% above RPI inflation once, on maturity after the five years is up, as opposed to every year like the Post Office account.

This is such a staggering difference I’ve re-read it several times to make sure I’m not missing something. As far as I can tell it makes the Post Office account, which pays the 1.5% annually, far superior.

Secondly, if you read the small print, you’ll find both the Yorkshire and the Barnsley bonds are actually being offered in conjunction with investment bank Credit Suisse, whom they term the ‘Account Manager’.

And consumer watchdog Which? has already raised concerns about how these Credit Suisse products (which they’re calling Protected Capital Accounts) are actually structured products.

Now, just because I prefer simple investments, that doesn’t mean that these bonds are automatically unsafe. As the prospectus for the Chelsea offer states:

Your money is protected in the same way as it is with any other bank or building society account you have. The Deposit Taker is therefore obliged to repay your original investment in full at maturity. Should the Deposit Taker default, there is no protection or guarantee provided by CSi or any other third party and you could lose some or all of your investment.

The Deposit Taker is a participant of the Financial Services Compensation Scheme which provides limited protection to deposit holders.

So theoretically you should at worst be able to appeal for up to the £85,000 compensation limit from the FSCS.

But the Credit Suisse products are still more convoluted than the Post Office account, which is a deposit account with the Bank of Ireland. (If that worries you, read this Which? account of how you’re covered).

Also note that both building societies are also offering another Credit Suisse product that offers 0.1% a year annually plus RPI inflation.

Presumably Credit Suisse had done the paperwork before the Post Office inflation linked bond with its annual 1.5% hit the shelves? I see no advantage, except again that the Credit Suisse product can be held in an ISA.

Will such bonds beat savings, anyway?

Comparing the minutia of these inflation linked bonds – and the many more likely to follow – is one thing, but there’s a big picture angle, too.

And that is that locking away your money for even 1.5% a year is a bit of a gamble.

It might seem a swell idea with RPI inflation running at 5.1% to get 1.5% on top for a return of 6.6% a year, but it’d be a stretch to bank on this situation lasting.

Essentially, you’re partly betting against the Bank of England’s credibility, given that it has officially targeted an inflation rate of 2% a year (albeit by the CPI measure, which is generally a little lower).

In a couple of years inflation might well be back around 2%, yet banks fighting for your deposits could be offering 6-7% in cash ISAs like a few years back. That would be a much better rate of return, and you’d be more likely to get it considering you could keep your money moving to chase the best rates – not the case if you lock it away for five-years in one of these inflation linked bonds.

Indeed, the Credit Suisse literature gives 30% growth in RPI inflation over five years as its example outcome.

Yet as Which? points out the last time this occurred was 1993!

Over the past 25 years, the average five-year return of the RPI index has been a far less exciting 16.1%.

Deflated expectations

With National Savings inflation linked certificates still withdrawn, it’d be churlish not to concede that the Post Office bond at least is worth considering, although that you can’t put it into an ISA is a real drawback.

Inflation proofing a chunk of what’s yours in lovely cash can’t be faulted.

Just don’t go overboard. For all the promotion of inflation linked bonds we’ll see over the next few months, the banks will simply be making hay from inflation worries while they can.

With the aftereffects of the credit crisis still rippling through the system, most still desperately need our cash. But I suspect they see no more chance of high inflation for years to come than does Bank of England governor Mervyn King.

1. Except in exceptional circumstances, and even then it will cost you. [↩]