Inflation and interest rates - what it means for you Go compare with our comparison table

Inflation and interest rates - what it means for you

01 February 2012 / by Oliver Roylance-Smith

In the last fortnight we have had a further vote on the base rate by the Bank of England’s Monetary Policy Committee as well as the revised inflation figures released by the Office for National Statistics. We take a closer look at what has happened and evaluate what this might mean for savers and investors.

The run continues

The Bank of England decided to maintain the base rate at 0.5% for the 34th consecutive month. The Monetary Policy Committee reduced the base rate from 1% to 0.5% on March 5th 2009 and it has stayed there ever since.

Although rates are expected to remain at this level throughout 2012, according to a leading forecaster the Centre for Economics and Business Research, there is every possibility that this could continue well beyond then and possibly until 2016.

Don’t mention the ‘R’ word

The think tank believe the UK economy shrank in the last three months of 2011 and is still contracting in the current quarter. This view is also echoed by recent forecasts at Ernst & Young which technically marks the UK is back in recession and a realization of the much feared double dip.
Low and weakening economic growth, which is threatened even further if the Eurozone takes a sharp turn for the worse, combined with continued high levels of unemployment all point to the Bank of England being forced to keep the status quo on the base rate for quite some time.

Inflation latest

Last week saw the release of the latest Office for National Statistics figures which showed a reduction in the Retail Price Index from 5.2% to 4.8% and the Consumer Price Index dropped from 4.8% to 4.2%.

These reductions were expected as part of the short term relief provided by the downward pressures from petrol, oil, gas, and clothing. Both RPI and CPI have fallen markedly since September 2011 when RPI reached a 20-year high of 5.8% and there is a general consensus that further reductions will occur in the coming months.

Keep it in perspective – down but still way over target

Although any reduction in inflation is of course good news for all, it is easy to lose sight of the ongoing impact even these revised levels can have on returns from savings and investments, which is even more pronounced over time.

Further, it should also be remembered that the current CPI rate of 4.2% is still over double the government’s target of 2%. This means that for everyone except non-taxpayers, you need to be earning at least 5.25% just to stand still otherwise you are losing money in real terms.

What does the future hold?

Although an overall reduction in inflation in the short term is expected by most, worryingly there is little discussion let alone agreement on what will happen should we dare to look beyond 12 months into the future.

Further quantitative easing is expected which according to Sir Mervyn King, governor of the Bank of England, could easily add a further 0.5% to inflation. In addition, the main contributing factors to the recent downward pressure, namely petrol, oil and gas, are also prone to high levels of volatility and significant price changes can occur quickly.

And lastly the whole deleveraging process, which by any standards is going to take a long time to unwind based on the current domestic and global economic uncertainty means there is every possibility that we could see inflation reaching record highs in the coming years.

So what does this mean right now?

The only real winners from all of this are those who are paying back their mortgage on their lender’s standard variable rate although even they might see rates climb in the near future as banks start to pass on the higher funding costs to mortgage customers. For those looking to achieve a solid rate and possibly keep pace or even beat inflation over the medium to long term the situation is a difficult one.

The persistent low interest rate environment results in low savings rates being offered. Although historically keeping your money tied up for longer offered fixed returns which were higher than the prevailing inflation levels, at present all except non-taxpayers are still falling short.

Think carefully before you act

Continued low interest rates plus uncertainty around inflation, particularly when looking beyond 12 months, does not provide us with a decision making friendly environment but as with any commitment you decide to take with your savings and investments, it is imperative that you think carefully and consider all of the options available before taking action.

Delaying taking action or losing sight of the real impact of inflation, especially over time, can produce painful results, not least for savers. Understanding the implication of low rates on fixed rate bonds, maximising Cash ISA allowances and giving full consideration to all of the alternatives available in the market are all sensible places to start.

See our article Inflation All Wrapped Up for a full review of the current options available as well as their pros and cons.

Compare capital protected savings options with the potential to beat inflation »

No news, feature article or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular investment please contact us for advice.

The value of investments and income from them can fall as well as rise and you may not get back the full amount invested. Different types of investment carry different levels of risk and may not be suitable for all investors.

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