Is it time to ditch inflation-linked deals?
High inflation can do terrible things to your savings, especially in a low-interest rate environment. Fail to earn interest at a higher rate than inflation, and you'll see the spending power of your money eroded over time.
Faced with exactly this problem, many savers have sought sanctuary in inflation-linked accounts over the past two years. These give the reassurance that, no matter how much inflation rises, the spending power of your savings will grow rather than fall.
But, with inflation rates starting to fall, has the time come to find another home for this cash?
Latest figures from the Office for National Statistics reveal that the official measure of inflation - the consumer prices index (CPI) - was 2.5% in March, down from 2.6% the previous month. This is now much closer to the Bank of England's target rate of 2%, and has more than halved since last September when CPI reached its peak of 5.2%.
It's also on the government agenda, with Chancellor George Osborne announcing in the March Budget that UK inflation would fall to 1.9% in 2013.
Experts also believe that inflation will fall this year. Suren Thiru, economist at Lloyds TSB, believes the rate will be close to 2% by the end of the year. "Energy bills will continue to fall and the VAT rise that was introduced in January 2011 has now fallen out of the calculation," he explains. "There is some uncertainty but I do expect the rate to fall."
A variety of factors are helping to bring down inflation. As well as reductions in the cost of gas and electricity, slowing price rises for food and transport have put downward pressure on inflation in recent months.
But forecasting inflation is far from easy. "Even the BoE doesn't always get it right," says Patrick Connolly, spokesperson for AWD Chase de Vere.
"A lot of inflationary pressure comes from overseas, for instance energy, oil and food, and the rate could also be affected by events such as terrorism or political uprisings. It's too soon to say inflation is dead: we need to see it continue to fall over the next few months."
While Connolly isn't prepared to write off high inflation just yet, neither is he prepared to recommend inflation-linked savings accounts. "Unless you're concerned about your savings keeping pace with inflation, I would be cautious of tying your money up in an inflation-linked product," he says.
Certainly, with inflation slowing, you may be better off going for a fixed-rate product.
Anna Bowes, director of savingschampion.co.uk, says these deals stack up well against the inflation-linked accounts currently available.
She points to BM Savings' three and five-year inflation-linked bonds, which pay the retail prices index (RPI) rate of inflation or, if greater, 3.7% or 4.3% respectively.
"It's good that it's linked to RPI, as this is usually higher than CPI, but once you take tax off your interest it won't beat inflation. More importantly, you will only get better rates than on a fixed-rate deal if inflation rises fairly significantly. This could happen but it does appear to be on a downward track," she says.
Getting out of these accounts can be costly if you do make the wrong inflation call. To extract your cash from the BM inflation-linked bonds will see you hit with a 5% charge on the amount withdrawn. Likewise, the Post Office's Inflation Linked Bond is subject to a ‘breakage charge' which, although unspecified, could see you left with less money than you paid in.
"Exit charges are likely to mean you have to ride out the term on any inflation-linked accounts you've already taken out," explains Jason Witcombe, director of Evolve Financial Planning.
But, he adds that you shouldn't be too keen to ditch all of your existing inflation-linked savings accounts anyway. "If you're lucky enough to have NS&I index-linked savings certificates, hang on to them as they're tax-free, so you'll benefit from gross interest. They'll sell out fast when they're next available."
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).