Inflation is finally falling. After hitting 20-year highs in September, there has been a steady drop in the speed that prices are rising in Britain.
"For four months in a row, inflation's stultifying, growth-stunting squeeze on UK households' real income has fallen,” said Ranvir Singh, chief executive of the market analysts RANsquawk.
But despite falling from 5.6% in September to 3.9% in January, the average family still needs to spend an extra £1,259 a year to maintain the standard of living they had this month last year – while an individual would have to spend £524 more, figures from MGM Advantage show.
[Related link: An investor's guide to beating inflation]
Why inflation’s falling
This is the first month for two years where inflation hasn’t been pushed up by VAT. In January last year George Osborne increased VAT to 20% and in January the year before Alistair Darling’s temporary VAT cut ended, pushing the tax back up from 15% to 17.5%.
So while it’s a welcome relief that there are no more rises in this tax on spending, the anniversary of a price hike is hardly a cause to cheer.
There is also a drop off in how fast transport costs, housing costs, the cost of communication, restaurants prices and hotel costs are rising as well as a slowdown in price rises for alcoholic drinks and tobacco.
Mortgage costs actually fell year on year – although these are excluded from the official measure of inflation.
On the downside, clothes and footwear, CDs and DVDs and banking costs (especially overdrafts) all increased inflation compared to their performance this month last year.
[Related link: See if you could save on your mortgage]
Impact on households
There’s no getting away from the fact that – even if price rises are slowing – life in Britain is getting more expensive.
The Bank of England is meant to control price rises – keeping them as close to 2% a year as possible. Price rises have exceeded that level since the end of 2009.
Bank governor Mervyn King explained this was a result of “increases in VAT, import prices and energy prices that were largely unexpected” in a letter to the Chancellor.
More practically, it means that your money buys you less and unless your savings are paying at least 3.9% – after tax – they are also losing money in real terms.
The biggest problem is for those on fixed incomes.
While state pensions and some private schemes rise in line with prices, many more don’t and retirees surviving on fixed incomes from savings or standard annuities get no respite from inflation.
“Retirees’ are disproportionately affected as they spend more of their income on food and fuel, the costs of which are rising faster than the headline rate,” said Aston Goodey of MGM Advantage.
The average household where the main occupant is between 65 and 74 needs to spend £819 more a year to maintain their living standards while homes where the main occupant is older will have to spend £523 more on average this year than last, MGM Advantage calculates.
Inflation fall 'good news for families'
What you can do about it
Data from MoneySupermarket.com shows five fixed-rate bond accounts pay rates that beat inflation for basic-rate taxpayers and 69 beat inflation for non-taxpayers. Some 26 fixed-rate ISAs pay interest rates higher than inflation, but there are no easy access or Cash ISA accounts that let your money grows faster than prices.
There are also inflation-linked savings bonds offered by Santander, Yorkshire Building Society, the Post Office and BM, a division of Lloyds Banking Group. These accounts promise to pay you more than inflation over the entire period of the account - but require you to lock your money away for between three and six years (depending on the deal). Also, the interest you earn is taxed at the same rate as you pay income tax, so unless you earn less than the tax-free threshhold, interest will not beat inflation overall.
With this being the case, it makes sense to use any spare cash to pay off debts, which generally charge a far higher rate of interest than any saving account pays.
“High inflation combined with low interest rates has particularly impacted on UK savers who have found it very difficult to gain any real returns on their savings pots,” said Kevin Mountford, head of banking, at MoneySupermarket.com.
“With this fall in inflation, there will be some savings accounts which will now beat inflation, and consumers need to make sure they are on the best deals possible to maximise the returns. The top paying savings accounts currently offer rates over six times that of base rate so by choosing these, you can reduce the impact inflation has on your pot.”
[Related link: See the top-paying savings accounts]
Other ways to beat inflation are riskier.
All physical assets — such as gold, silver, oil and the like — see their prices rise and fall independent of the fortunes of the pound or inflation. While investing in these things might preserve your money's value, they don't pay an income. This means you have to eat into your capital to spend anything. On top of that, their values are not fixed, so a crash in gold or oil prices could wipe out a chunk of your savings and selling them isn't a cost-free process.
Many shares listed in the UK also do a lot of their business overseas, which means UK inflation and a falling pound will see their prices rise to compensate. Shares also frequently pay dividends, some as high as 7% of their value, so there is an income to be had from your money.
But — of course — share prices and dividends aren't fixed. A fund of shares — such as the Bloxham Global Equity Income, the Jupiter Income Trust and the Invesco Perpetual Income fund — can mitigate this risk somewhat, and shares and funds can frequently be held in an ISA, avoiding tax.
[Related link: Open a stocks and shares ISA]
If you're not comfortable investing shares or funds, you might be more comfortable investing in people. A slew of companies now let you lend money directly to other people in the UK, securing incomes well above inflation.
Companies like Zopa let you get returns of 7.6%, while Funding Circle (where your money goes to businesses you choose) can get you interest of 8.4% and Rate Setter can get you up to 7%.
Most of these let you get access to your money early, as well as making provisions to protect you from losses if anyone you lend to goes bust or defaults on a loan — however, to secure the really top rates you will have to invest in riskier businesses (although default rates have been low so far).
[Related links: Social savings deals]
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