Despite previous assurances from the Bank of England that current levels of inflation are temporary it now looks as though high inflation could be here to stay for some time.
The Bank of England hoped and predicted that inflation would fall back towards its’ 2% target, however minutes from the latest meeting of the Monetary Policy Committee (MPC), which sets interest rates, show that the outlook for inflation is far from rosy.
Furthermore research published this week by Brewin Dolphin shows that inflation, in particular rising food and energy prices, are starting to bite with 70% of consumers cutting back.
Outlook for inflation
Despite June’s fall in inflation, rising food and energy prices has prompted the MPC to raise its expectations for inflation in months to come.
The minutes of July’s meeting of the MPC said: “Despite the fall in CPI inflation in June, it was likely that inflation would rise further, to over 5pc, in the coming months”
“In the light of recent developments in utility and food prices, the peak in inflation was likely to be a little higher and come sooner than the Committee had previously expected.”
The news of higher inflation is generally greeted with dismay, but is it really that bad, who are the winners and losers when inflation rises?
The most commonly thought of beneficiary to rising prices are those people with debt, whether it is in the form of mortgages or loans.
Take a homebuyer who has a £100,000 mortgage on an interest only basis over 15 years. At the end of the 15 year term they will still have to repay £100,000 but it will only be worth £73,856 if inflation averages 2% over the term of the mortgage, if inflation is double, at 4% the real value of the debt would be just £54,208.
Of course this theory only works when wages rise in line with inflation and at the current time this is not happening. The Brewin Dolphin survey showed that 74% did not believe their income would rise in line with inflation over the next year.
Savers and those people on fixed incomes are the main losers when inflation rises.
Savers are struggling to find accounts where the interest rate matches current levels of inflation. With the Consumer Prices Index (CPI) at 4.2% a basic rate taxpayer needs to get a return of 5.25% gross on their savings to match inflation. For a higher rate tax payer the rate is even higher at 7%.
Options for savers to get an inflation beating return are few and far between, with no savings accounts paying a rate above 5% at the current time.
Even for non tax payers or Cash ISA investors, savings need to be locked away for four or five years to get an interest rate to beat inflation.
One option for savers is an account where the rate of interest is linked to inflation, generally RPI, but again these are few in number, although the newly relaunched National Savings & Investments Index Linked Certificates are proving popular with savers.
Those people on fixed incomes, often pensioners who may have bought a level annuity, will see their buying power eroded as inflation rises. A level of income of say £14,000 would be worth just £12,022 after five years of inflation averaging 3%.
Older generations are particularly hard hit by rising inflation at the current time as a greater proportion of their expenditure is on food and energy which is rising in price faster than other goods and services.