Be prepared - the real threat of inflation to our savings

Be prepared - the real threat of inflation to our savings

02 October 2012 / by Oliver Roylance-Smith

The threat of inflation to our income and capital is something which we must all be aware of. Understanding the impact this can have, even over a short period, is perhaps more important now than ever before. We therefore take a deeper look into the outlook for inflation, a primary consideration when deciding what to do with our hard-earned savings.

Inflation latest

According to the Office of National Statistics (ONS), the latest inflation figures show that the Consumer Price Index fell to 2.5% in August, having risen from 2.4% to 2.6% in the previous month. The Retail Price Index dropped to 2.9% in August, down from 3.2% the previous month.

The drop in CPI was fuelled by downward pressures from furniture, household equipment and maintenance, housing and household services (particularly domestic gas) and clothing and footwear prices.

Bank of England – guide us

Good news? In isolation, of course a reduction to the headline rate is always welcome, but only if this does indeed accurately reflect the day-to-day reality for all of us, especially those who rely most on our savings. Let us not forget that this is only a snapshot of the last 12 months up to the end of the previous month. Therefore, at best, it gives us an insight into what has already happened and therefore does nothing to prepare us for what might happen.

Since the first publication in 1993, each quarterly inflation report from the Bank of England has been the subject of much conjecture. Unfortunately its forecasting track record has not been one that fills us with confidence, and the use of purposely vague language and non-committal opening remarks provides us with little more than a loose overview.

Commodity prices rise – a time for concern?

Perhaps of more importance is that one of the main upward drivers within these latest figures was the rising cost of transport, particularly motor fuels - motorists once again start to feel the pain. Indeed, the last few months have seen a sharp increase in many commodity prices, especially crude oil, wheat and corn, all of which have risen by well over 20% since the end of June.

The latest Bank of England quarterly report from August shows the Bank's view is that the probability of CPI reaching 5% between now and the end of 2015 is zero. At the same time, it also reminds us that twice in the past four years inflation has risen above 5% as a result of external price pressures. The next report is due in mid-November but I fear this stance may well have changed somewhat.

Inflationary environment

This is a very important trend to be aware of - something which has an immediate impact on most of us. There is, of course, usually a lag between the increase in price of raw produce and the retail price, but the impact of rising commodity prices on inflation is well known, particularly as the increasing oil price feeds throughout to the wide economy.

The relationship between the oil price and UK inflation is a worrying one and the pressure built up by the recent commodity price rises will be a strong contributing factor to an increasing inflationary environment.

Growth required

Another important contributing factor to what might happen to inflation is the impact that economic growth can have. Certainly for the government’s austerity measures to really work and have a meaningful impact on debt levels, there needs to be solid signs of economic growth.

Unfortunately this much-needed growth stimulus needs to be significantly higher than is currently being evidenced, and with the recent slashing of the UK growth forecast by the Organisation for Economic Co-operation and Development, the outlook here is far from upbeat.

Insight from the top….

In a recent interview with Channel 4 News, Bank of England governor Mervyn King stated, “I think we’re beginning now to see a few signs of a slow recovery, but it will be a slow recovery. After a banking crisis, one can’t expect to get back to normal and I fear it will take a long time”.

When asked about the government's deficit-cutting plans, which are designed to curb the gap between spending and income by 2015, he said, “it would be acceptable if that target was missed, as long as it was a result of slower global economic growth”. Not the language of confidence and prosperity that the economy needs.

Interest rates and quantitative easing

Earlier in September the Bank of England’s Monetary Policy Committee held the base rate at 0.5% and maintained its quantitative easing (QE) programme at £375bn. The latter decision was seen as a straightforward one as the Bank is currently half way through a four month programme of £50bn which started in July.

The minutes from this latest meeting showed that the rate-setters voted unanimously to keep QE at its current level, although some members saw extension to the scheme as more likely than not, while others saw the risks to inflation in the medium term as being more balanced around the target.

Not all are convinced

Both Spencer Dale, the Bank’s chief economist, and the deputy governor Paul Tucker have been on record recently casting a shadow over the effectiveness of further QE.

Spencer Dale said recently that printing more money “might do more harm than good” and could cause harm for the future, explaining monetary policymakers face substantial uncertainty, whilst Paul Tucker admitted that QE had lost some of its “bite”. The report in the Telegraph added that Tucker said, “technically we could do more, its just a question of what we think the risk to inflation would be.”

Inflation definitely on the agenda

John Chatfield-Roberts, chief investment officer at Jupiter Asset Management, echoes this concern and has warned that inflation could near double digits over the next five years, becoming the ‘achilles heel’ of the UK economy.

In response to the recent fall in CPI, Chatfield-Roberts warned the current QE programme is storing up inflation problems for the future and that “over a five year period you can imagine inflation being towards the double digits. I am sure no one wants it. It may be that my five year time horizon is not long enough, but I see it to be the inevitable outcome”.

Reality bites

The reality is that the small fall in inflation is overshadowed by the fact that the CPI has been above its 2% target, set by the government, for nearly 3 years, throughout which interest rates on savings has been desperately low. The current market has more savings accounts that don’t beat inflation than those that do.

Inflation erodes the real value of our savings and those hit the hardest are the over 50’s who not only rely on their savings more than anyone else, but who have also seen the spending power of their capital slashed by this toxic combination of continued low interest rates, the Bank’s QE policy and the threat of rising inflation.

Risk warning

It is a dangerous path to make a decision based on what has happened in the last 12 months. Inflation is definitely on the agenda and should be considered a major concern due to the huge potential impact on our nest eggs.

Relying on historical data when making plans for the future should also come with a risk warning, and with the current economy not only giving us more questions than answers, the future outlook is one that demands our full attention.

Important considerations

Remember, if you do tie yourself in now and inflation goes up by only a small amount during your fixed term, your real return (i.e. the return after inflation and tax) could easily be eroded. You must therefore always take a considered view of what could happen to inflation before acting.

The market has become more developed here and there is a wide variety of terms you can tie into - notice accounts, for example, offer a convenient middle ground between instant access and fixed rates.

Also, make sure you are aware of all of the options open for your savings, be it held directly or within a cash ISA. Fixed rates continue to form the backbone of many savings pots but with few competitive longer term offerings currently available, there are some attractive alternatives to consider. Balancing a mixture of accounts with different terms and rates can often provide both the desired level of access as well as a competitive overall return.

Options to consider

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No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular plan. If you are at all unsure of the suitability of a particular product, both in respect of its objectives and its risk profile, you should seek professional advice.

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