Inflation hits savers

Today’s announcement that the Retail Price Index rose by 2.4% over 2009 means that even most ‘best buy’ savings accounts have failed to keep up with inflation for taxpayers.

Annual inflation, as measured by the Retail Price Index (RPI), rose from 0.3% in November 2009 to 2.4% in December, the biggest monthly increase seen since July 1979 (when the rate increased from 11.4% to 15.6%).

The Consumer Price Index (CPI) also rose, to 2.9%, although as this measure excludes housing costs such as mortgage interest and council tax it’s a less relevant figure for most of us than RPI, which includes them.

Why has inflation risen?

The bulk of this rise is largely due to oil prices and other items such as clothing costing more than they did a year ago.

Should you be worried?

Yes...if inflation remains higher than savings interest rates longer term.

Based on Bank of England figures, the average branch-based easy access savings account paid just 0.18% over 2009, meaning a basic rate taxpayer has typically seen the buying power of their savings fall by more than 2.2% over the year. If these rates persist then £1,000 of savings would buy just £892 of goods and services after 5 years and £796 after 10.

Even ‘best buy’ accounts have struggled to keep pace. If annual RPI continues to rise at 2.4% then a basic rate taxpayer needs to earn 3% before tax and a higher rate taxpayer 4% just to keep up with inflation.

The current best buy easy access savings account is Coventry BS First Class Postal Savings Account which pays 3.30%, including a 1.3% bonus for the first year. However, other than Ulster Bank at 3.10% and Scottish Widows Bank at 3.01% all other easy access accounts are currently paying less than 3% gross.

Will inflation remain a threat?

The exceptional events that contributed heavily to lower inflation figures over much of 2009, namely low oil prices and the VAT cut, are unlikely to be repeated in the near term. I think inflation will likely remain a problem for savers over the course of this year, especially as interest rates are unlikely to rise by much, if anything. But beyond that is very difficult to predict.

What can I do?

If you’re a taxpayer then holding your savings in cash ISAs may offer some respite, as interest is paid tax-free. Those under 50 can save up to £3,600 before 6 April 2010 and up to £5,100 thereafter, while those aged 50 and over already enjoy a £5,100 annual cash ISA allowance. The Standard Life Direct Access Cash ISA currently pays the highest rate on £1 at 2.65%, although if you’re saving £3,600 you can enjoy 3% with the Teachers Building Society. Find out more about cash ISAs on our cash ISAs page.

If you don’t mind tying up your cash then take a look at NS&I Index-Linked Certificates, which pay a fixed rate of interest over and above inflation. Both the 3 year (19th Issue) and 5 year (46th Issue) certificates currently pay RPI plus 1%, i.e. 3.4%, tax-free. This is equivalent to 4.25% gross for basic rate taxpayers and 5.67% for higher rate taxpayers. Of course, inflation could move either way going forwards, but even if it does become negative once more the Certificates will still pay 1% tax-free, better than a typical savings account. Read more about them on our NS&I page.

Is higher inflation good news for borrowers?

Yes, because rising prices reduce the value of their debt in real terms. For example, if you have a 20 year interest only mortgage of £150,000 and inflation is 2%, then the ‘real’ value of your debt at the end of the term would be just £100,141.

I’m sure the Government is secretly pining for higher inflation for this very reason. It would welcome higher inflation to reduce the real value of its £844 billion debt, provided it doesn’t jeopardise our economic recovery.

Tools

You can check the impact of inflation on your savings using our Savings vs Inflation and How Much? savings calculators.