ECONOMISTS are predicting rates could fall as low as 1% as the Bank of England seeks to stave off a prolonged recession.

The Bank cut rates by a surprise 1.5 percentage points on Thursday to just 3%, their lowest level in more than half a century, and cited the “very marked deterioration in the outlook for economic activity at home and abroad”.

Capital Economics, the consultancy, is predicting rates will fall to 1% next year, although the average forecast is for a trough of 2.5%, according to a poll of analysts by the data firm Reuters.

However low they go, millions of savers face sharp cuts in the interest they earn. Banks and building societies have cut rates for existing savers by up to 1.76 percentage points since Bank rate started falling last December — even though it had fallen only 1.25 points before last week’s cut.

Cater Allen, a private bank owned by Abbey, has been one of the worst offenders, slashing rates on its Sovereign 30 account by 1.76% on balances of £5,000 or more. First Direct, meanwhile, has reduced rates by up to 1.45%.

We look at how to manage your finances in a world of low interest rates.

SAVERS

Fixed-rate bonds are a good way to protect your income from falling rates. However, rates are tumbling in the wake of last week’s Bank rate cut and advisers say new bonds will be unlikely to top 5.5%.

ICICI, the Indian bank, which led the market for most of the year, slashed its account by 0.50 points from 7.1% to 6.6%. That left Close Brothers, the investment bank, at the top of the best buy tables with an account paying 7% for a year on a minimum £10,000 deposit — however, this rate is only guaranteed to last until tomorrow.

Netherlands-based AK Bank also offers 7%, but is only part-regulated by the Financial Services Authority so savers would have to apply to the Dutch scheme first if the bank defaulted. The Dutch authorities guarantee the first ¤100,000 (£81,300).

Savers looking for stability after the collapse of online Icelandic providers Icesave and Kaupthing can receive a 100% guarantee over their deposits from government-owned Northern Rock and National Savings & Investments (NS&I). Northern Rock pays 6% for one, three or five years.

NS&I, however, has been criticised for slashing interest rates for existing savers. Last week it cut its Direct Isa from 4.8% to 3.3%, having reduced by more than Bank rate last time round.

Kevin Mountford of Moneysupermarket, a comparison site, said: “Spread your money between different institutions to ensure it’s fully protected, but with interest rates falling it’s also vital to maximise returns. Fixed-rate bonds offer the highest rates for now — but be quick because they are disappearing by the hour.”

The top paying fixed-rate Isa from National Counties is at 6.01%. Barclays offers 5.58%.

INVESTORS

Gilts, which are bonds issued by the government to raise money, are yielding above 4% for about 10 years and your cash is safe unless the government goes bust.

The Treasury’s 2020 gilt, for example, pays a fixed 4.75% for 12 years. Gilts are issued at £100, so you would get £4.75 a year for each gilt. However, prices have risen recently and the 2020 issue is currently trading at £100.91. You would get back only £100 at the end of the term, meaning you would suffer a small capital loss which reduces your yield to 4.65%.

Advisers caution against locking up your money for so long — but shorter-dated gilts have lower yields. The 2012 and 2014 issues yield 3.7% and 4% respectively.

Adrian Lowcock of the adviser Bestinvest said: “People are moving to gilts as a defensive mechanism and prices have risen with demand.”

Alternatively you could invest in gilts via a fund, such as Allianz Pimco Gilt Yield, which is yielding 4.2%, or Royal London UK Government Bond on 3.61%.

Advisers are also tipping corporate-bond funds, which are yielding up to 13%. These tend to perform well when interest rates fall because their fixed income looks more attractive in a low-rate world, although recently prices have been hit hard by fears of defaults — the average corporate-bond fund has fallen 12% in the past 12 months, according to the data firm Financial Express.

However, some analysts think the sell-off has been overdone and that present yields more than compensate for the risk.

John Pattullo of Henderson, the fund manager, said: “Valuations in the investment-grade corporate-bond sector look compelling. The market is now pricing in a default rate of 35% over the next five years. While we may be at the beginning of a more ruthless default cycle, we don’t subscribe to the view that nearly one in three companies won’t emerge from this crisis.”

Lowcock recommends funds such as Invesco Perpetual Corporate Bond, yielding 4.3%, and Fidelity Moneybuilder Income, yielding 4.5%.

You can buy direct through a stockbroker or a bank.

Alternatively, equity income funds — a dirty word at the start of the year due to their poor performance relative to the rest of the market — are coming back into vogue. Many believe that the companies held by such funds (those that pay good dividends) are undervalued after the turmoil that culminated with October’s crash.

Lowcock said: “Artemis income has a good fund manager in Adrian Frost. It has fallen 30%, but still stayed in the top 20 over the year.”

BORROWERS

Borrowers on trackers who can afford to maintain their repayments at the level they were at before last week can boost the equity in their home or pay off their loan more quickly by asking their lender to keep payments as they were before the rate cut.

This can help to protect you from further falls in house-prices by building up the equity in your home. Take a property valued at £420,000 with a £252,000 mortgage — that is, 40% equity — on a tracker at 5.44%. Repayments would come down £216 based on the 1.5 percentage-point fall. You could, however, forgo cheaper repayments, and use the reduction to overpay your mortgage, which would fall to £234,274 within two years. You would gain 4% more equity in your home and pay off your loan faster.

David Hollingworth of London & Country, a broker, said: “Most lenders allow you to make overpayments of up to 10% a year without a penalty, although some have caveats. Others may charge you if you pay off your loan early, so check your contract.”

APPROACHING RETIREMENT

Advisers are recommending that retirees fix their annuity rates now, after hefty rate cuts in recent months and the prospect of more of the same caused annuity rates to slide. The top rate from Norwich Union has come down by £60 over the past month to £7,040 a year, for a 60-year-old male with a £100,000 pension pot, according to Alexander Forbes, the annuity bureau.

David Marlow of Alexander Forbes said: “We’ve been expecting level annuity rates to start to slide for some time. This is happening now that global interest rates are beginning to fall to combat recession.”

Prudential cut its inflation-linked annuity rate by £160 to £3,866 this month. Canada Life, however, aggressively increased its rates to top the inflation-linked table last week, raising them by £83 to £3,998.

Overall, however, retirees are still better off today than they were at the start of the year when level annuity rates were some 5% lower.

DISAPPOINTED BORROWERS

The Halifax collar took us by surprise

Aniesa and Zayn Blore, of Surbiton, have a Halifax tracker at 0.36 points below Bank rate on their £300,000 mortgage. They pay 2.64% compared with 5.39% when they remortgaged a year ago. Aniesa, 31, an occupational therapist, and Zayn, 34, an IT consultant, are worried Halifax will impose a “collar” if rates fall below 3%. She said: “We didn’t know that Halifax had this condition when we took out the mortgage. It’s disappointing.”

OVERPAYING PAYS

We can shave six years off our loan

Ian Banks, and his girlfriend, Emma, has a £120,000 tracker mortgage with Cheltenham & Gloucester, at 0.79 points above Bank rate. His interest rate was 5.29% (based on Bank rate of 4.5% before last week’s cut) with monthly repayments at £721. After the 1.5 point reduction, his rate is now 3.79%, or £619 a month — a saving of £102.

However, if Banks, who lives in Hove, East Sussex, maintains his monthly payment at £721 — overpaying by £102 a month — he could shave nearly six years off the length of his mortgage and the total cost of the loan would fall from £185,871 to £170,464, saving £15,407.

Drew Wotherspoon of John Charcol, the broker, said: “The rate cut has provided an opportunity for many borrowers to make a dramatic difference to their mortgage. If borrowers can comfortably afford the payment they made just last month, then they should seriously consider continuing at this level. The effect this can have is impressive, with even those on a modest mortgage of £100,000 seeing their mortgage paid off six years earlier. A low-interest-rate environment is the right time to focus on paying back debt.”

Banks also has the option to place the £102 — £1,224 a year — in a tax-free Isa or savings account.

Invested in the top fixed-rate Isa from National Counties at 6.01%, the money would be worth about £7,000 in five years, or they could earn £6,751 interest in five years invested in the top-paying instant saver from AA at 6.46%, according to Andrew Hagger of Moneynet, a comparison site.