Let’s not beat around the bush. Inflation is the new financial demon in the room. Not quite the ogre of the 1970s when it hit 24 per cent, but it’s slowly beginning to wreak havoc with many households’ finances as rising energy and food bills take their toll on tight budgets.
Last week, the cost of living notched up to 4.2 per cent in the year to October – compared with 3.1 per cent in the previous month and above the 2 per cent target set by the Bank of England.
It means inflation is now at its highest level for nearly a decade and there is every likelihood that in the months ahead, it will continue to rise. The Bank of England has already indicated it could hit 5 per cent by next spring before falling back. Financial hawks believe it could go even higher.
Heating up: Inflation is the new financial demon in the room
‘Inflation of 4.2 per cent is a concern,’ says Roger Clark, partner at wealth manager The Private Office. ‘Yet it hardly represents a return to the bad old days of the 1970s and 1980s when inflation was constantly in double digits – and some employees received monthly pay increases to help combat it.
‘Nevertheless, households will be focusing on this metric for the first time in years – and searching for ideas to keep their finances in order and their savings from being devalued.’
Although inflation, as Clark says, is corrosive in its own right, undermining savings and driving up household bills, what makes the current situation more scary are the other demons that lie in wait.
Higher interest rates are one. They are likely to rise in December, though given that the Bank of England surprised everyone by resisting the urge to push up the base rate this month from 0.1 per cent, it could dig its heels in again and leave any increase to the New Year.
Yet the fact that savings rates are already tickling up suggests a base rate increase is imminent. Bad news for homeowners whose mortgages are linked to variable – rather than fixed – interest rates. Goodish news for savers, though they will still be unable to find any savings account that comes anywhere near paying 4.2 per cent interest – the rate necessary to ensure the ‘real’ value of their cash deposits are not eroded by inflation.
The other demon lurking in the undergrowth is a particularly venomous one. In April, taxes will rise to pay for the Government’s ‘reform’ of social care and rebooting of the National Health Service.
The 1.25 percentage point increase in National Insurance Contributions – and corresponding increase in tax on dividend income – will eat into many households’ income.
There will be no increase in personal allowances to help offset the impact of these tax rises (Chancellor of the Exchequer Rishi Sunak has already told us that bad news).
The Institute for Fiscal Studies (IFS) has spelt out the impact of these demons on household income – and it doesn’t make for pleasant reading. Someone on a salary of £30,000 will need a pay rise of 7.1 per cent in the year to April 2022 to maintain the standard of living they currently enjoy. I can’t imagine many employers, some facing tough business challenges of their own, are in a position to grant such employee awards.
The financial pain, the IFS says, will be felt by all households irrespective of income, though it acknowledges any steep jump in the energy price cap in April would affect low-income families most.
Those on benefits, including the state pension, will also struggle as the 3.1 per cent increase due in April will fail to make good the corrosive effect of inflation – then possibly running at five per cent.
It’s a point not lost on former Pensions Minister Baroness Altmann who failed last week to get the Government to reassess its decision to suspend the state pension triple-lock guarantee. She says the 3.1 per cent increase will ‘plunge more elderly people into poverty’. So, what can be done to fight the curse of inflation against a backdrop of future rises in interest rates and taxes?
Quite a lot, especially if you’re a mortgage borrower, someone who is keen to grow their long-term wealth and happy to take on board investment risk – and don’t mind going through bank and credit card statements checking whether any costly monthly subscriptions ought to be cancelled.
Homeowners can act now to fix rates
Although a majority of homeowners have taken advantage of record low mortgage prices in recent years to fix the interest rate they pay on their home loan, many haven’t. Also, thousands of borrowers will be on a fixed deal that is about to come to an end. For those still on a standard variable rate – typically anything between 3.5 per cent and 5 per cent plus – it now makes sense to move on to a fixed rate before the base rate rises.
Ray Boulger, mortgage expert at John Charcol, says: ‘Consumers can do little to reduce the cost of their gas, electricity and the petrol or diesel they put in their car. But many can cut their mortgage bills.’
David Hollingworth, of broker L&C Mortgages, urges prompt action. He says: ‘Lenders have been steadily nudging up fixed rate prices on new loans and remortgage deals. Yet they remain extremely attractive, allowing borrowers to pin down their biggest household outgoing to a low rate.’
The best remortgage deals, he says, are currently 0.99 per cent for a two-year fix from building society Monmouthshire, based on a loan-to-value of up to 75 per cent – and 1.34 per cent, fixed for five years, from Nationwide (loan to value up to 60 per cent). So, taking a repayment loan of £150,000 with 20 years remaining, someone on a standard variable rate of 3.59 per cent would pay £877 a month. On Monmouthshire’s rate, the payment comes down to £689, saving £188 a month. Nationwide’s five-year fix would cost £713, saving £164 a month.
For those on a mortgage deal that has less than six months to run, a fixed rate loan can be secured now that will kick in once their current arrangement ends. ‘Any fixed rate loan taken out now will look cheap in a year’s time,’ predicts Boulger. Wise words.
Savers should switch to better deals
Everyone should try to have some cash savings set aside for emergencies such as the boiler breaking down or losing their job.
The equivalent of three months of household expenditure is considered by most experts as prudent. Cash savings also make sense for those saving up for a holiday or a big purchase such as a new car. But these savings are currently dwindling in real value terms because the interest you get will come nowhere near the current inflation rate of 4.2 per cent. Two messages come out of this.
First, savers should not oversave – a message the Financial Conduct Authority is desperate to get across.
Second, savers should not stop shopping around for best rates even if such action merely slows down the damaging impact of inflation.
Anna Bowes, co-founder of rate scrutineer Savings Champion, says: ‘If you have money in the bank paying 0.01 per cent interest, with inflation at 4.2 per cent, its value will halve in real terms in just over 16 years. If you switch to the best easy access account paying 0.67 per cent, its value will halve in around 20 years. By switching, it doesn’t eradicate the damage inflation is doing to savings. Only a Bank of England rate rise will start closing the gap between savings rates and inflation.’ In the last few days, rate rises from NS&I (on its popular income bonds that pay monthly interest) and RCI Bank (on its latest batch of fixed term accounts) suggest a better savings environment is around the corner. But the rate increases are nothing to write home about.
Got spare cash? Then invest it
Any cash in the bank not allocated to meeting a possible financial emergency or a specific savings project should be invested in the stock market.
Alex Shields, a chartered financial planner at The Private Office, says shares provide a ‘better opportunity to achieve a return above inflation in the long term’.
But he cautions: ‘If you choose the investment route, it is important you are comfortable with the bumps in the road associated with investing – bumps which can be a shock to those used to savings accounts where the capital value does not fluctuate.’
Investing, he adds, is best through a tax-friendly wrapper such as an Individual Savings Account or pension. As for those parts of the UK stock market that could prosper on the back of higher inflation and interest rates, financial stocks should do well.
This is because banks can make bigger profits from lending while asset managers benefit from people moving money out of cash into investments. Investment fund Artemis UK Select has 34 per cent of its portfolio in financials.
Commodities such as gold are also a useful hedge against inflation. Dzmitry Lipski, head of funds research at wealth manager Interactive Investor, says fund WisdomTree Enhanced Commodity offers investors ‘a broad and diversified commodity exposure, including industrial metals, precious metals and agriculture’.
Change providers to cut household bills
Although the recent seemingly endless hikes in energy prices, and resulting collapse of many suppliers, has brought switching to an abrupt halt, households can seek savings elsewhere.
Myron Jobson, of Interactive Investor, says many people will have monthly subscriptions to services they no longer use, need or can justify. Culling them, he says, might not result in big monthly savings, but they will ‘add up over time’.
He also urges households to see if they can get a cheaper broadband deal – especially if they have just come off a special introductory offer.
Those nearing the end of a mobile phone contract should shop around – and consider cheaper alternatives such as keeping an existing phone and taking out a cheap SIM cardonly deal. Websites such as Uswitch can help find the cheapest offer.
For pensioners over state pension age who are on a low income, it’s essential they check whether they are eligible for pension credit.
This benefit can pave the way for a free TV licence and the warm home discount scheme which knocks £140 off your electricity bill. See gov.uk/pension-credit
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.