Money Insider: More misery for savers as interest rates keep falling

The savings market has been in free-fall since the Funding for Lending scheme was introduced on 1 August last year, with UK savers seeing their rates and incomes slashed.

This cheap source of government-funded cash means that high street banks and building societies are no longer relying on retail savings balances from savers and therefore now have little need to appear in best buy tables.

This has had a big impact on interest rates for savers. For example, if you look at the rates paid on fixed rate bonds the best buy rates have fallen by more than 40 per cent in some cases over the last 12 months.

In August 2012 you could have picked up a 1 -year bond paying 3.45 per cent; today the best you'll find is 2.05 per cent from Kent Reliance.

For people relying on their savings to produce income to help balance the household budget, this sort of reduction will be causing major financial problems. The lower 1-year rates mean that someone with a £20,000 nest egg will now receive £280 less in interest income (pre-tax) than they would have done last year.

It's not just 1-year bonds that have been affected: even the best 5-year fixed rates have tumbled since last August, from 4.5 per cent to just 2.9 per cent today with FirstSave.

It seems that if you're a saver, there's bad news wherever you turn. On Tuesday National Savings and Investments rubbed salt in the wound when it announced that it was reducing the annual Premium Bond prize fund rate by 0.2 per cent to 1.3 per cent from 1 August.

As a result the odds of each £1 Bond number winning a prize will be cut to 1 chance in 26,000 rather than 1 in 24,000.

But there was a rare glimmer of better news last week with Skipton Building Society launching a 7-year fixed rate bond paying 3.5 per cent (3.45 per cent for monthly income). However, the downside is that the maximum balance is restricted to £10,000.

It's a good rate in the current market but 7 years will be too long for many people to consider locking their cash away.

Since Funding for Lending was introduced, the savings best buys are now dominated by less well-known brands and specialist players including Kent Reliance, ICICI Bank UK, Aldermore and Shawbrook Bank.

This shouldn't deter savers from investing with these providers as they are protected by the Financial Services Compensation Scheme (FSCS) guarantee which protects the first £85,000 per account holder.

It's no surprise that more people are turning to less well-known savings providers as well as alternative options such as peer to peer providers to try to get a decent return. For example RateSetter was advertising 5-year savings bonds fixed at 5.5 per cent this week.

Just to put the peer to peer rates into context, if you put £25k with First Save's best buy at 2.9 per cent for 5 years the annual interest return would be £580 after basic rate tax, whereas with RateSetter at 5.5per cent it would generate £1,100. Over the full five- year term the difference is £2,600.

Although peer to peer providers don't offer the FSCS guarantee, they do have their own safety nets in place to protect savers' money. RateSetter uses a provision fund which has ensured that every customer has got every penny back they've invested. Zopa, another of the main peer to peer providers, operates a similar scheme via its Safeguard fund.

Funding for Lending may have helped bring down mortgage rates but it's been nothing short of a disaster for those with savings. The situation is being compounded by rising inflation - unfortunately unless the Bank of England has a surprise up its sleeve there's no sign that the situation is going to improve any time soon.

Andrew Hagger is an independent personal finance analyst from moneycomms.co.uk