What to do as inflation returns

Inflation - shoppers passing a huge £1 sign © Getty Images
Inflation will hit savers and borrowers alike

And it’s back. Numbers out from the Office for National Statistics (ONS) today show that consumer price inflation (CPI) has jumped to 2.3%* with retail price inflation (RPI – the measure we all used to pay attention to) hitting a slightly scary 3.2%.

Food, clothing, housing, culture, recreational goods (particularly personal computers) and furniture prices are all up. Core inflation (the number that strips out food and energy) showed a particularly large jump (1.6% to 2%).

And there’s probably more to come. Lots of retailers will have been hedged against the fall in the pound so will be late to the price-rise party. Some of the recent utility price rises might also not yet be in the numbers.

We’d also point out that with the liquidity created by quantitative easing (QE) still knocking around in the markets; the Bank of England’s oft-repeated plan to ignore inflation overshoots (to somehow make up for missing the 2% target on the downside in the past); the possibility of a renewed round of global protectionism; and the political muttering about fiscal stimulus all still out there, the risks are very much on the upside for inflation.

The official forecast has CPI at 2.8% by Christmas. That is unlikely to be the end of it. There are upsides to the fall in the pound (the latest CBI Industrial Trends Survey shows rising strength in manufacturing). But while not all the price rises can be put at sterling’s door, this sharp rise in inflation is clearly something of a downside, particularly give that it once again suggests that average real wages are static. In the first three months of the year wages rose 2.2% – take inflation off that and no one’s going to be feeling much richer.

That’s a feeling that’s going to hit savers too – whether they know it or not. A recent survey from OnePoll/Abundance asked people what effect inflation running at 3% a year would have on the value of their cash savings after a decade. 11% thought it would have no effect at all. 43% just didn’t know. 20% guessed it might reduce the value of their savings by 3% over the full period. And a mere 25% figured out the full horrific answer: that an innocuous sounding 3% inflation rate will remove over 25% of your purchasing power within a decade.

CPI at these levels is also unlikely to make borrowers happy. We already know that some members of the MPC are ready to change their stance on rates (ie to vote to raise them) if there is much more in the way of positive economic surprises (one member wants to raise rates now). These kinds of numbers have to start making them feel a tad uncomfortable with having interest rates set at 0.25%. We wouldn’t expect any immediate action (see the point above about the BoE being OK with inflation above target for a bit). But a rise in rates is definitely closer than it was – perhaps inside 2017 rather than 2018.

It’s worth noting that pre crisis and pre our newly bonkers monetary policy system there was a rule of thumb that assumed that the base rate would be about 2% above inflation and that mortgage rates would be 2% higher again. That would make the base rate not far off 4.5% and mortgage rates more 6% than the 2% we are all used to.

That isn’t going to happen in a hurry in today’s UK, but it is still worth thinking about the following: UK interest rates have fallen non-stop for ten years (and were pretty low for seven years before that). That means there is a generation of borrowers out there (mortgage holders in particular) who have no experience of rising rates. They could find the turn tricky.

So what should you do in response to the inflation numbers? Savers should make sure they are getting all they can from their providers. There are very few accounts that will give you a real return with inflation at 2.3% (not even the new NS&I savings bonds announced in the budget – they pay 2.2%). So get the best you can and make sure you pay as little tax as possible by using your Isa allowance to the extent you can.

Borrowers should lock in low rates where they can. Salaried workers should remind their employers that they should not have to suffer real wage falls. And finally anyone looking for a quote for a final salary pension transfer might like to get on with it: valuations are generally inversely related to gilt yields, and these drifted up on two- and ten-year gilts after the inflation data was released.

*The ONS also published its new measure of inflation CPIH for the first time. This includes additional housing costs and also came in at 2.3

  • Carl Wells

    So should first-time buyers buy and lock in? the risk for anyone with savings is presumably a combination of higher interest rates but higher salaries that result further property price rises. This, presumably, is what central bankers would still like to achieve. Sizable deposit here, but have waited for the crash that never came …

66% off newsstand price

12 issues (and much more) for just £12

That’s right. We’ll give you 12 issues of MoneyWeek magazine, complete access to our exclusive web articles, our latest wealth building reports and videos as well as our subscriber-only email… for just £12.

That’s just £1 per week for Britain’s best-selling financial magazine.

Click here to take advantage of our offer

Britain is leaving the European Union. Donald Trump is reducing America’s role in global markets. Both will have profound consequences for you as an investor.

MoneyWeek analyses the critical issues facing British investors on a weekly basis. And, unlike other publications, we provide you with the solutions to help you turn a situation to your financial advantage.

Take up our offer today, and we’ll send you three of our most important investment reports:

All three of these reports are yours when you take up our 12 issues for £12 offer today.

MoneyWeek has been advising private British investors on what to do with their money since 2000. Our calls over that period have enabled our readers to both make and save a great deal of money – hence our position as the UK’s most-trusted investment publication.

Click here to subscribe for just £12