As expected, the latest inflation figures from the Bank of England have seen another increase. The Consumer Prices Index (CPI) showed that inflation for the 12 months to May 2021 was 2.10%, up from 1.50% in April and higher than the 1.80% predicted.
So, for the first time since July 2019 CPI inflation has breached the Government’s target of 2% - but only just, so surely that’s OK? Right? You realise the true state of affairs today when you look back to 2019, when the Bank of England Base Rate was 0.75% and there were plenty of savings accounts that could match or beat CPI.
Although the best easy access and 1-year fixed rate bonds in July 2019 were still paying less than the CPI rate of 2.10%, they were far healthier rates of 1.50% AER and 2% AER respectively at that time – and you’d only have needed to tie up your money for 2-years to earn an inflation beating rate of more than 2.20% AER. If you had chosen a 5-year bond back then, you are probably feeling pretty pleased with yourself right now as you could still be earning up to 2.80% for another three years!
The problem for savers today is that with Base Rate at just 0.10% the savings landscape is very different and all of a sudden there are no standard adult savings accounts currently available that will even match, never mind beat inflation at a rate of 2.10%.
It’s easy to sweep the low interest rates under the carpet as you may be earning at least something on your cash savings, albeit small, however if higher inflation and lower interest were to stay, you’ll soon see how quickly your cash is eroding in real terms. It's a toxic combination - you’re effectively already earning a negative interest rate, even without the Bank of England moving into this territory.
Encouragingly, the Bank of England has indicated that it expects this spike in inflation to be temporary due to an inevitable increase in demand of released lock-downers rushing out to buy things.
The problem really occurs if this isn’t temporary. As Toni Meadows, Chief Investment Officer at The Private Office (TPO) says “Inflation on its own isn’t a problem. But accelerating and cemented inflation is”.
And it’s not just CPI that experts like Toni are looking at. There are a number of inflation measures that could be of concern.
Take the Product Prices Index (PPI). In a similar way that the Consumer Prices Index measures the change in prices of products that we buy as consumers, PPI provides an important measure of inflation. PPI indicates the price of goods sold by UK manufacturers; it includes costs such as labour, raw materials and energy as well as interest on loans, site or building maintenance, and rent – so it’s the viewpoint of the seller rather than the consumer. While CPI inflation for May was 2.10%, the UK PPI was a hefty 4.60%, more than double CPI and an indication of possible price rises down the line.
Meadows, explains “The Producer Prices Index is increasing faster than the Consumer Prices Index – and this is something that is happening globally, not just in the UK.
This is down to the fact that the world is opening up but the supply chain has been disrupted. When there was no activity during lockdown, many suppliers closed down and stop producing goods that are needed to make consumer items. As the world has opened up again, these suppliers couldn’t open up as quickly so there is more demand than supply. This includes labour – while there is large unemployment as a whole, there are specific areas where labour supply is short which adds to the problem.
Why is this a concern? It’s not too much of a problem in the short term, but if it keeps happening, will companies have to pass on these costs to the consumer? If so, we could expect to see the cost of living rise even faster.
Although PPI could be considered as an indication of what might happen to the end of the line consumer prices, it’s not a pre-curser to what will actually happen. But it’s important to keep an eye on the PPI as well as the CPI.”
As mentioned above, the reason that inflation is important, especially to savers, is that although your capital deposit may appear to be intact, and indeed increasing in value as interest is added, if that interest is less than inflation, it is in fact effectively a negative interest rate.
For example, if you deposit £50,000 into the best easy access account which is paying 0.50% AER, after 12 months although the balance would have increased to £50,250 gross, in real terms it has actually fallen in value; if the price of items that you buy with your money increases by more than the interest you earn, you can’t buy as much with it. Your ‘purchasing power’ has diminished.
With inflation at 2.10%, if you are earning 0.50% AER the real value of your money will have fallen to £49,216 after a year – and after five years, it would be worth just £46,203 – that’s a fall in value of over 7.5%. That is why inflation is known as the silent killer.
Those who leave their cash festering with a high street bank or NS&I will feel the effect of inflation more than others – If you leave your cash earning just 0.01%, a deposit of £50,000 would have fallen to just £48,976 after a year, or £45,088 in real terms over five years, assuming an inflation rate of 2.10%. Nearly 10% of your money will have been consumed by inflation.
If inflation continues to rise, as is predicted, even for the short term, the damage will be greater.
For those who have no choice but to leave their cash in a savings account, the best you can do it to make sure you shop around and take advantage of the best rates available - switching to mitigate the effect of inflation is far better than leaving the funds earning nothing. And by taking advantage of best buy rates, you can at least reduce the effect of inflation on your hard-earned savings.
For others, perhaps the tipping point has arrived. This week, once again, the Monetary Policy Committee voted to keep the base rate at 0.10%, and although financial markets are now estimating that the first post-Covid base rate rise will happen sooner than previously suggested – it is still expected to remain at this current level until mid 2022.
With cash in savings accounts losing its real value, is it time to look elsewhere to try and keep at least some of your assets keeping up with the cost of living?
The problem is, the risks that you’ll need to take are different, so if you’ve not considered investing before it’s important to make sure that you understand what else might be available and what it could mean for your cash.
For some initial thoughts, take a look an article written by our colleagues at The Private Office: How to stay ahead of inflation
If you’re worried about rising inflation and think you might be holding too much in cash, perhaps you'd like to explore other options, so why not get in touch. We’re currently offering all those with £100,000 or more in savings, investments or pensions a FREE financial planning review with one of our TPO colleagues, worth £500. You can find out more here.
@savingschampion
Find us on Facebook