Inflation. It is enough to fill anybody with dread. Money only stretches so far, and it is even harder to stretch a pound when it is only worth 97.7 pence. Well, that is the reality after inflation was recently announced to have exceeded the Bank of England’s 2% target to a level of 2.3%.
The Office for National Statistics released a bulletin on the 21st of March, revealing inflation to be much higher than previously thought. This news has come as a surprise to many, and will affect three groups of people negatively. Read on to find out if you are one of them.
Why is the rate so high?
Before we look at exactly who will be affected and why, it is worth looking back to see how this news fits in with previous years.
2.3% is the highest level since 2013, and the Bank of England recently stated that it expects inflation to peak at 2.8% next year. Mark Carney, the Governor of the Bank of England, also mentioned in October 2016 that a 3% rate is a very real possibility.
Why is the rate so high? Trump? Brexit? Inflation takes many factors into account, but it would be hard to ignore the two major events of last year. The Office for National Statistics suggested that a rise in fuel costs and oil prices contributed significantly to the upward effect, as well as the pound’s weakness induced by the referendum.
“A penny saved is a penny earned.”
When Benjamin Franklin said this, he probably didn’t have inflation on his mind. Savers will be hit by the news, as any savings account offering a return of less than 2.3% will result in a real terms loss. Your annual statement will tell you that you now have more money than you had before, but that money will be worth less.
It’s not all bad news; there are still ways to beat the inflation. Not many, mind you. A small handful of savings accounts offer an interest rate above 2.3%, such as the five-year fixed rate bond from NS&I, offering a rate of 2.5%. Atom Bank offer a 2.4% fixed bond account of the same length, so providing you are happy to put your money away for the long term, you could beat inflation. However, this is only a temporary solution if inflation continues to rise. Also, if interest rates rise in an effort to combat inflation, you could find yourself tied into a financially uncompetitive savings account.
#2: People on fixed incomes
Retirement comes with its own set of financial hurdles, but people who are living on a fixed income will be feeling the squeeze now more than ever.
If you have bought an annuity from your pension provider, it will be on one of the following terms:
• Fixed income; known as a level annuity
• Increasing income; known as an escalating annuity
If your income is fixed, your buying power will slowly start to reduce for the duration of your retirement.
#3: People who haven’t had a pay rise
Pay rises often offset the increasing costs of life, improve morale and are generally a good thing all around. Some workplaces find themselves stuck with pay freeze policies to ensure their financial stability.
If your workplace has a pay freeze in place, or you did have a raise but it was less than 2.3%, then you will find yourself in the group of people who will be worse off.
In a similar way to the fixed annuity example stated above, people who are earning the same or less than the rise of inflation have reduced spending power. For the same amount of money, your shopping basket will be slightly lighter, which is great if you have tired arms but not so great if you need to fill a fridge on a budget!
Que Sera, Sera
There is also a fourth group of people who will find themselves affected, and they come in the form of borrowers. The law of unintended consequences can be harsh, and borrowers could find themselves worse off if the Bank of England increases interest rates to try and combat inflation. Such rises could see the cost of borrowing on mortgages, credit cards and personal loans rise in the form of higher interest rates.
If you have been keeping a keen eye on the financial news, then you will see mixed reports. Some are wild-eyed and prepping for doomsday, and others are essentially saying “so what?”
Leading financial expert Paul Lewis suggests that inflation could hit 4.1% by Christmas in a recently published article. His breakdown of the figure and calculations can be seen here. If he is correct, life will become much harder for beleaguered savers, as well as people on a fixed income.
If you have any questions or queries about how inflation will affect you, please call us on 0115 933 8433. We’d love to have a chat and we are always here to help.