"Sticky" inflation: How will this affect your finances in 2012?

Tuesday, 24 April 2012 09:35

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Two members of the Bank of England’s Monetary Policy Committee (MPC), Adam Posen and deputy governor Paul Tucker, have said this week that inflation may remain higher than anticipated during 2012.

This means that the record squeeze on household finances could last further into this year, longer than expected.

The Bank of England’s target rate for inflation is two per cent and the consensus earlier in the year was that the consumer prices index (CPI) measure of inflation would continue to fall from its September 2011 peak of 5.2 per cent towards the bank’s target through the course of 2012.

For six months this estimate looked like it might prove to be accurate as the rate fell to 3.5 per cent but the likelihood of that has receded following the latest official inflation figures out last week from the Office for National Statistics (ONS) that showed the CPI rate up from 3.5 per cent to 3.6 per cent in March.

MPC members change views on inflation

This prompted Adam Posen to say last week that the Bank of England may have to change its policies if core inflation failed to show a sustained fall. The minutes from the Bank’s last meeting of the MPC said “there was a greater chance than before that above target inflation would persist into the medium term."

Meanwhile, deputy governor Paul Tucker said at a conference in Liverpool last week that inflation could stay above three per cent for the rest of this year and that the latest inflation figures were “uncomfortably above target.”

And economic forecasters the Centre for Economic and Business Research (CEBR) are expected to amend their view on where inflation will be in the final quarter of 2012 this week from 1.7 per cent to 2.7 per cent this week.

Howard Archer, Chief UK & European Economist at HIS Global Insight said: “While inflation still seems likely to eventually trend down appreciably further, there is a very real danger that it will prove sticky over the next few months as high oil prices impact.”

So, how will the level of inflation being higher than expected for longer affect your finances?

Savers

Savers need interest rates to increase but that still seems a long way away, though the likelihood of base rate rising sooner than previously thought appears to have increased as the Bank of England re-thinks its policy on how to combat inflation.

The continued high level of inflation makes it more difficult for savers to find a real return on their investment. They now have to find an account that pays 4.38 per cent to beat tax and inflation, up from 4.25 per cent last month.

This is looking an increasingly difficult target following a statement from National Savings & Investments (NS&I) that said it was unlikely that it would issue inflation-linked savings certificates this year.

Moneyfacts said that there are now just 50 savings accounts that beat inflation, down from 79 in March. However, for 40 per cent rate taxpayers who need to find a return of 5.83 per cent, there are no regular savings accounts and they need to look for the best ISA deals.

Household expenses

Petrol has now reached a record high price and the Bank of England has said that one of the main factors that could keep inflation high is the volatile oil market.

The average monthly cost of petrol to a typical family now exceeds their food bill for the first time ever. It now costs £71 to fill a 50-litre family car. If you need to do this every week then it outstrips the average cost of feeding a family with two children every week as the average grocery shopping bill for a family of four is £70.

And some food staples have risen fast over the last 12 months. The Financial Times reports that the cost of meat rose by 6.1 per cent annually based on March’s figures and that this has led to a 20 per cent rise in the theft of meat from supermarkets.

Save our Savers, the pressure group who oppose the Bank of England’s monetary policy of low interest rates so vehemently do not believe falling prices would harm the economy.

In their article entitled “The reality of inflation,” they say: “The Bank of England appears utterly petrified of falling prices, presumably believing that consumer demand will stop dead if people knew they could buy things more cheaply in the future.

“Wouldn’t gently falling prices work wonders for consumer confidence, making us feel a little wealthier instead of blanching at prices that make us feel much poorer with every beep of the supermarket scanner?”

Free guide to inflation

Investments

Investments typically beat inflation, even at 3.5 per cent. Roughly 90 per cent of UK equity funds have a yield in excess of 3.5 per cent and companies are paying record levels of dividends.

A report out today from dividend income monitoring firm Capita Registrars says that in the first quarter of 2012, UK companies paid out a record £18.8 billion in dividends. It expects this figure to rise in later quarters of this year.

Investing in foreign companies may help investors find a return that beats inflation as many other emerging economies are running much higher levels of inflation and their companies are growing at a rate above the UK’s level of inflation.

Pensions

Higher inflation is affecting pensioners with drawdown pensions, according to a report out by a group of MPs last week.

However, this year’s increase in the state pension was based on a higher rate of inflation than we have now, so there is some comfort.

If you are due to retire soon and are hunting for a retirement income through an annuity, it is vital to use the open market option to access better rates.

Annuity rates dropped by eight per cent in 2011 and this trend has continued into 2012. Part of the reason is the Bank of England’s policy of quantitative easing which pushes the yields on gilts down.

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Mortgages

The continued “stickiness” of inflation could cause the Bank of England to raise interest rates earlier than previously anticipated.

Most economists still believe a rate rise will not happen before the end of 2012. However, a Reuters poll published last week indicated that Just two weeks ago only 40 per cent of economists polled said that base rate would rise from 0.50 per cent by the end of 2013. This has now increased to 50 per cent.

Millions of homeowners have benefitted from low interest rates but this cannot go on forever.

The outlook and impact of higher inflation

The outlook for inflation for the rest of the year will depend on a number of factors. Oil prices, the euro debt crisis and the growth of China and India could all impact inflation in the UK and it is likely that inflation could fluctuate up and down over the next few months.

Higher and prolonged inflation will also hinder the UK’s ability to grow in 2012 and that could affect jobs and investment as well as household finances and the ability of savers to get a real rate of return on their investments.

Howard Archer, from HIS Global said: “If consumer price inflation does prove to be sticky over the coming months, this will have worrying implications for UK growth prospects. Sticky consumer price inflation would maintain an appreciable squeeze on consumers’ purchasing power and dilute hopes that consumers will increasingly step up their spending as 2012 progresses.”

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