Rising inflation: How it's hurting your finances
The plunging value of the pound due to fears over Brexit, combined with rising food and fuel prices means our money is losing value faster than it has done for years. Inflation is once again a real concern.
The consumer prices index (CPI) rate of inflation made a shock rise to 2.3% in February where it also remained in March (the latest figures available at the time of writing), higher than the Bank of England’s 2.05% forecast. Many expected rising food and fuel prices to cause an increase in the rate of inflation, but the surprise came in the news that in February the ‘core’ inflation rate – one that excludes food and fuel – rose to 2%.
“Inflation for cultural and recreational goods, especially personal computers, rose sharply,” says Ruth Gregory of macroeconomic research company, Capital Economics. This is “perhaps an early sign that the effects of sterling’s fall are feeding through more quickly than had been anticipated”.
The worry now is that this is just the beginning of an upward trend; while it's far too early to know if inflation will hit the dizzying heights of the 1970s, when it reached 25% in 1975 and averaged 13% a year across the decade, it does seem as though the only way is up.
So what does this all mean for you?
Everyday expenses will be the areas where we feel the impact of inflation most.
Fuel prices hit an 18-month high at the start of the year, they’ve fallen back slightly since then but you are still paying more to fill up than you were a year ago. The average price for a litre of petrol is currently £1.20, compared to £1.03 a year ago.
Rail fares are also on the up, rising by 2.3% on average in January. Likewise, the Big Six energy firms are currently announcing price rises averaging 8%.
So what can you do?
To cut motoring costs, go to petrolprices.com to find the cheapest petrol pumps in your area. For cheaper energy bills, pay by direct debit and check if another provider can offer you a better deal.
Use our free energy tool to check if you can save by switching. And to combat rising food costs, buy own-brand items, and compare prices according to price per weight rather than the labelled price.
While prices are moving steadily up, savings rates are going nowhere. Low interest rates also magnify the impact of rising prices, as our money will buy even less over time. For example, if you put £50,000 in a savings account five years ago that paid 1% interest it would have grown to £52,551 now. That's £2,551 worth of interest, right?
Unfortunately, due to inflation, you would need £54,984, to buy the same things as you could have bought with £50,000 five years ago. So, in real terms you money’s spending power has shrunk by £2,433.
So, if you want your savings to keep pace with inflation you need a bank account paying at least 2.3% interest. Ideally, an Isa so your returns aren’t affected by tax, but with the new personal savings allowance you may be better off with a standard savings account.
Unfortunately, there is only one savings account (other than regular savers, which require you to have a current account with the bank) offering a rate that beats inflation – Ikano Bank’s five-year bond paying 2.35%.
Read our round-ups of the best cash ISA and best savings rates
To fix or not to fix? That's the question on many mortgage holders' lips. For the past eight years homeowners have benefitted from record low mortgage rates. But mortgage rates are starting to slowly rise now, meaning it could be time to opt for a fix and lock in a low rate before they disappear.
There are still some incredibly good long-term fixes available which could allow you to secure a low fixed rate for five or even 10 years. Meaning you could avoid any interest rate turbulence over the next two years as Britain journeys out of the EU.
Gilts (government bonds), and to a lesser degree corporate bonds, look particularly vulnerable, because they pay a fixed rate of income that buys less as inflation eats into it – although there are inflation-linked bonds that try to counter this. As far as investing in UK equities is concerned, companies that produce real things that people will buy regardless of price, such as big food retailers, tobacco companies, utilities companies and pharmaceuticals, look the safest bests.
"These are all defensive industries which are best placed to perform in difficult economic times," says Patrick Connolly, spokesperson for financial planning firm Chase De Vere.
Ultimately, you're not going to be able to beat inflation with your savings, but over the longer term there's potential for greater total returns that could outpace inflation.
Inflation hits pensions hardest when they are used to buy an annuity – or a regular income – in retirement. The vast majority of annuity holders buy level (unchanging) annuities, rather than escalating or index-linked annuities that increase each year. This is because a level annuity promises a greater yearly income to start with.
However, that amount will never change; by contrast, index-linked annuities rise in line with inflation each year, while escalating annuities go up annually by a set amount.
The good news is, since the arrival of pension freedoms two years ago, you no longer have to buy an annuity. With inflation rising you may want to keep your retirement savings invested for longer so your money can (hopefully) continue to grow.
In order to make sure you have a regular income to cover your essential expenditure you could choose to use only part of your retirement savings to buy an index-linked annuity. That way you get the best of both worlds – peace of mind that you will always be able to pay your bills combined with a pension pot that is still growing.
How is inflation calculated?
Traditionally, there have been two measures of inflation: the consumer prices index (CPI) is the official measure, while the retail prices index (RPI) tends to be slightly higher – it's 3.2% at the moment – because it includes housing costs. Both indices look at the costs of a basket of approximately 700 goods and services that typify consumer spending habits; an average figure is then calculated by getting around 180,000 price quotations each month.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
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).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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).
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.