CPI inflation hits 5.2%: What does it mean for your money?
Tuesday, 18 October 2011 11:50
By Ben Salisbury
Today’s inflation figures from the Office for National Statistics (ONS) highlight the pain facing households through higher energy bills and food costs and pensioners and savers who face a fall in real incomes as high inflation eats away at the rate of return available on savings income and pensions.
Economists expected the rate of the consumer prices index (CPI) to increase to 4.9 per cent. The actual increase to 5.2 per cent has taken both the Treasury and analysts by surprise. The retail price index (RPI) rate of inflation increased to a 20-year high of 5.6 per cent.
The consensus is that inflation will fall back in 2012 when the effect of the VAT increase on January 1st 2011, is stripped out of the figures. However, we have three more inflation readings before then and it is possible inflation will increase to an even higher level over the next three months.
There are not many ‘winners’ when inflation is high. Certainly not savers who now have to find a savings account that pays more than seven per cent.
Those on benefits will see their income rise from April 2012, as the September inflation figures are used to calculate benefit levels for the next financial year. However, the government will base these figures on the CPI reading rather than the RPI reading which means the increases will be less.
So, let’s take a look at the reaction to today’s news on inflation from different parts of the financial world and illustrate just what the rise means for our wallets.
How do the new figures impact on the Chancellor and the UK’s fiscal policy?
According to Howard Archer from IHS Global Insight, “September’s jump in inflation is particularly bad news for Chancellor George Osborne as it is September’s consumer price inflation rate that is being used to set the increase in many benefits as well as the state pension. As inflation is appreciably higher than was projected by the Office for Budget Responsibility back in March, this adds to the Chancellor’s difficulties in hitting his fiscal targets.
“The Bank of England was expecting consumer price inflation to exceed 5% in the near term before falling back sharply in 2012, so September’s jump does not materially change the monetary policy outlook.”
The effect on benefits and pensions means that payments will overshoot the Office for Budget Responsibility’s forecast for 2012-13 by £1.2 billion.
What does high inflation mean for savers?
Savers will continue to lose out through a combination of high inflation and a low base rate. As mentioned earlier, basic rate savers now need a rate of return of seven per cent to keep up with inflation. For those paying the 40 per cent tax rate it increases to more than nine per cent and for savers who pay the 50 per cent tax rate, they will need to find a rate of return of about 11 per cent.
Post Office Director of Savings and Investments Richard Norman said: “Savers have had a hard time of late, and another inflation increase will be bad news for many. However, people can protect themselves from inflation through inflation linked savings accounts.”
This is true to a certain extent. Savers can get closer to matching inflation through an inflation-linked bond but the rate of interest the Post Office use is linked to inflation in January of each year and may not match inflation levels for the rest of the year.
Does it mean there are investment bargains to be had?
Yes, there are some positive effects for investors. Equities become more attractive to investors because the earnings potential from bonds falls as Paul Mumford, Senior Fund Manager at Cavendish Asset Management explains:
“From an investor point of view it is worth remembering that inflationary pressures can carry a silver lining for equities.
“With inflation now running at over five per cent, eroding the capital value of bonds, equities are rendered yet more attractive compared to fixed income assets, which at current are struggling to provide investors with decent income. By contrast, equity dividends are steadily increasing. The dividend yield on the All-Share index is just under 3.5 per cent, covered over 3 times by earnings.”
Does the high level of inflation mean the Bank of England is abandoning its target rate of two per cent for inflation?
Some analysts believe this is the case, though the Bank of England itself strenuously denies this and says that inflation will naturally fall back in 2012.
Thomas Paterson, Chief Economist at Gold Made Simple was scathing with his view of the Bank of England’s performance.
He said: “This is the 22nd month in a row that the Bank has missed its government-mandated target of 2%.
"Whatever external forces the Bank of England blames for the overshoot, the bottom line is that for all of 2011 it has created more than double the inflation the government has asked it to.
"By any standards, that's an epic failure.
"The credibility of the Bank is hanging by a thread. And what has been its response to missing its government-mandated inflation target for nearly two years? Its response has been to print more money — and not just a small amount but an expansion of the UK's already bloated balance sheet by almost a third.
“We believe high inflation is the unstated but unequivocal strategy of the Bank of England to reduce the UK's deficit and bring our economy back from the brink."
Meanwhile, Schroders’ European Economist, Azad Zangana said: “The Banks has consistently pointed to the increase in VAT as a temporary factor that is distorting the true rate of inflation, however today’s numbers show that when the ONS excludes the impact of increase in taxes, CPI inflation is still running at 3.7% - well above the Bank’s target.”
The impact on UK households
Apart from savers and pensioners the effect of high inflation impacts markedly on normal households who are suffering higher food and energy prices at a time when wage increases are low. Inflation now outpaces wage growth by a factor of three.
TUC General Secretary Brendan Barber said: “The cost of living is now rising three times faster than wages - squeezing people's living standards even tighter.
“Today's figures also confirm that the government's CPI stealth cut will reduce the value of benefits and pensions by 0.4 per cent next year.”
According to MoneySupermarket.com, 71 per cent of British consumers will need to turn to their savings, credit cards or overdraft to fund rising bills.
Kevin Mountford, head of banking at MoneySupermarket.com said: “Now definitely isn’t the time to be apathetic. If you’re in a position where you cannot see a way out then don’t bury your head in the sand; sit down and review at all of your outgoings to make sure you are on the best deal for your circumstances. Cutting unnecessary expenditure on household bills can go some way to help reduce the financial stress. Take the time to switch as the savings could be far greater than anticipated."
Review your providers and switch to a better deal
Now really is the time to sit down and take stock of your household bills and see if you can shave off some of the expense. Council Tax and water bills are set and you can’t find a better deal except by using less water (this will also help reduce your utility bills).
However, despite the arguments about energy companies profiteering and issuing a bewildering array of confused tariffs, it is possible for most people to save at least ten per cent on their energy bills.
Additionally, take a look at the package you have for broadband and home phone and see if you can improve the deal you have on those costs.
Another simple saving is to change your bank account to one that pays you for switching such as the new deals recently released by Santander and The Co-op.
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