Cost of living soars to 14-month high

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The headline rate of inflation soared to a 14-month high in January as VAT returned to its standard rate of 17.5%.
The Consumer Prices Index (CPI) - the official measure of the cost of living - jumped to 3.5% last month, from 2.9% in December.
The year-long VAT cut to 15% came to an end on 31 December, lifting the price of alcohol, tobacco, hotels and restaurants.

The higher cost of crude oil from a year ago has also pushed up the price of petrol and other transport costs, while retailers offered lower discounts in the post-Christmas clearance sales this January.

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The spike in inflation means the Mervyn King, governor of the Bank of England, must write a letter to the chancellor explaining why inflation has shot up by more than 1% above the Bank’s medium-term target of 2%.

This will mark the sixth time he has been forced to do so since 2007.

Meanwhile, the Retail Price Index (RPI) - which some economists say is a more accurate measure of inflation as it includes housing costs - has risen from 2.4% to 3.7%.

Start of a trend

Economists are now predicting that inflation will rise further in February as more retailers pass on January’s VAT hike - although this is expected to drop back in the second half of the year.
Howard Archer, chief UK and European economist at IHS Global Insight, says: “Given the extent of the spike up since last September, there is obviously the risk that inflation could be stickier than expected and not fall back as much or as quickly as hoped.

"Nevertheless, we believe consumer price inflation could well be back under 2% by the end of the year and then largely stay there during 2011.”
The Bank of England recently indicated that it expected inflation to peak at 3.5% before falling back below 2% later this year.


The news that inflation has risen so sharply will come as a blow to savers - as a lack of competitive savings rates mean it is tough to find a new account that can keep up with inflation.
A basic-rate taxpayer currently needs to find a savings account that pays at least 4.38% in interest to stop their savings pot eroding away. A higher-rate taxpayer has to earn at least 5.83% - however, there are currently no fixed-rate bonds paying interest above 5.83%, according to data provider Moneyfacts.
“Each month, inflation is cutting deeper into people’s spending power and lower savings interest rates are creating an even bitterer pill to swallow," Darren Cook, spokesman for Moneyfacts.

"Those who are relying on their savings pot to subsidise other income are seeing their savings being eroded on average by 2.92% per year for a basic-rate taxpayer and 3.06% for a higher-rate taxpayer."

The average instant access account currently pays just 0.86% - which equates to 0.69% for a basic-rate taxpayer and only 0.52% for a higher-rate taxpayer.

David Black, banking specialist at Defaqto, say: “The stark reality is that there are now no taxable instant access or notice accounts that will give a real rate of return to even a basic-rate taxpayer let alone a higher-rate taxpayer.

Even when it comes to tax-free cash ISAs, Black says there are only 39 available that pay a real rate of return based on RPI inflation for a £3,600 balance.

“Savers have to be incredibly proactive to get the best deals and, apart from some cash ISAs, the only bank and building society savings accounts that give the higher-rate taxpayer any chance of a real rate of return are a handful of regular savings and current accounts as well as a few fixed-rate bonds that require linked investments in the stockmarket," he adds.

"The total number of such accounts barely reaches double figures and many of them have conditional additional requirements. Those reliant on savings interest to supplement inadequate income will be devastated by this double whammy of rising inflation and low interest rates."



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