What to do as inflation returns

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

  • Caitlin Rogers

    This is happening again, I remember what happen last year as UK left European Union. The cheaper prices of hotel rooms, clothing and wine offset the rising prices of food and air fares as core inflation figures tallied a flat reading of 1.3%. What will be coming next this year?

    Source: https://www.itrader.com/en/marketreview/daily_14_09_2016

  • Peter

    Other plus point to buying now is locking in low interest rates – five or even ten year rate fixes look interesting. Having said that the actual price of the house is still far too high.

Merryn

Claim 12 issues of MoneyWeek (plus much more) for just £12!

Let MoneyWeek show you how to profit, whatever the outcome of the upcoming general election.

Start your no-obligation trial today and get up to speed on:

  • The latest shifts in the economy…
  • The ongoing Brexit negotiations…
  • The new tax rules…
  • Trump’s protectionist policies…

Plus lots more.

We’ll show you what it all means for your money.

Plus, the moment you begin your trial, we’ll rush you over THREE free investment reports:

‘How to escape the most hated tax in Britain’: Inheritance tax hits many unsuspecting families. Our report tells how to pass on up to £2m of your money to your family without the taxman getting a look in.

‘How to profit from a Trump presidency’: The election of Donald Trump was a watershed moment for the US economy. This report details the sectors our analysts think will boom from Trump’s premiership, and gives specific investments you can buy to profit.

‘Best shares to watch in 2017’: Includes the transcript from our roundtable panel of investment professionals – and 12 tips they’re currently tipping. The report also analyses key assets, including property, oil and the countries whose stock markets currently offer the most value.