Is deflation good or bad for your money?

Posted on May 19th, 2015 | Categories - News

Is deflation good or bad for your money?For the first time since Harold Macmillan was Prime Minister Inflation, as measured by the Consumer Prices Index (CPI), turned negative last month.

But what does it mean for your savings, pensions and investments, we have the answers. But, first things first though, exactly what has happened?

To put is simply, the CPI (usually) measures that rate at which prices are rising. It does this by comparing a ‘basket’ of goods and services from one month to the next and reporting the change.

For the first time since 1960, CPI has turned negative, or to put it another way, prices fell slightly, by 0.1%, in April.

Most of us would say that sounds like good news, but is that really the case? Who will be affected and will you be better or worse off?

Bill payers

With sluggish wage growth since the financial crisis, particularly in the public sector, the news that the cost of living is static and fell in April will be good news for most people.

It isn’t just a few pence people are saving either; falling oil prices mean the average motorist is expected to save around £140 this year.


Pensioners

Although the State Pension increases each year, a large proportion of many pensioners’ income is fixed, as most people who bought an Annuity chose a level income, rather than one which increases each year.

Deflation is therefore good news for people with a fixed income, which are eroded when prices rise.


Borrowers

Low inflation, or indeed deflation, helps to keep interest rates low, which is good news for borrowers, particularly those on variable rate mortgages.

Although, if a prolonged period of deflation were to cause wage growth to stall, this would be bad news for borrowers, as it is rising wages which help to erode the true cost of debt and loan repayments.


Savers

Savers are in an interesting position, on the one hand low inflation means it is possible to make a real return on cash held in bank and building society accounts; deflation only makes it easier to get a ‘real return’.

However, as we have already pointed out, low inflation will continue to put downward pressure in interest rates.

It is bad news however for those savers who have accounts where the interest is linked to inflation. With both CPI and RPI (the measure used by National Savings Index Linked Certificates) at very low levels, the interest received will be lower than many savers expected.

Whatever your view, it is clear that savers are going to have to continue their long wait for interest rates to rise for some time to come.


Investors

Some economists warn that a prolonged period of deflation can cause economic growth to stall, as consumers and businesses put off making large purchases, in the hope that prices will fall further.

This could impact in the economy and ultimately share prices, which many of us hold in our pensions and ISAs (Individual Savings Accounts).

There is another view though. The period of deflation is expected to be short, with inflation moving to more normal levels towards the end of the year. Some economists therefore believe we could see a short term spike in consumer spending, which would benefit the economy.


Deflation: good or bad?

Mark Carney, Governor of the Bank of England, said deflation was “unambiguously good” for the UK economy.

Some will agree, others won’t, but whatever your view, with inflation set to return to more normal levels at the end of the year, the effects of falling prices will probably only be enjoyed, or endured, for a few months.