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The latest update from the Office for National Statistics (ONS) puts the Consumer Prices Index (CPI) measure of inflation at 3.4% in the year to February, a significant drop from the 4% recorded in both January this year and in December 2023.
While the latest figure is much smaller than the 11.1% recorded in the year to October 2022 – a 41-year high – the figure remains uncomfortably above the government’s long-term target of 2%.
The reason inflation continues to remain higher than target is down to a long-lasting legacy of damaging economic conditions.
These include a knock-on from elevated energy and food prices – triggered in large part by the war in Ukraine – combined with high interest rates, a tight labour market featuring accelerating wage rises, plus ongoing global supply chain bottlenecks.
Although the influence played by these elements have either begun to level off or fall, other factors also contribute to the economic state of play. For example, increased geopolitical tensions in the Middle East and along the vital Red Sea shipping route, are threatening to send the oil price higher and elevate the cost of certain goods, all adding to inflationary pressures.
In aggregate, these factors have combined to produce a drawn-out cost-of-living crisis for numerous households and businesses. Food price inflation has become a particular problem, although there are now signs that the eye-watering soaraway figures associated with the sector in recent months are now starting to flatten off.
In recent years, prior to 2022, inflation had been relatively low. But, given the current state of play, it’s only natural for people to be concerned about what lies ahead on the inflation front.
Here’s a reminder of why inflation matters to our finances.
What is inflation?
Inflation is the term that’s used to describe the increase in prices over time. The UK government sets an inflation target of 2% which the Bank of England is tasked with maintaining using monetary policies including the raising and lowering of interest rates via changes to the ‘Bank Rate’.
Broadly speaking, inflation has remained relatively stable in the UK over the past 30 years as the following graph shows. The blue line in the chart represents the UK’s actual inflation rate and how it has varied compared with the Bank of England’s continual 2% target (red line).
As the chart shows, inflation soared from about 2% in 2021 peaking at a figure more than five times that level in the autumn of 2022. In recent months, despite stalling between December last year and January 2024, the broad direction of travel has been downward leaving us with today’s figure of 3.4%.
For savers, the spectre of inflation means making money can be something of a challenge.
Elevated inflation has a devastating impact on the real value of cash at a time when the best easy-access individual savings accounts are only paying around 4% and about a percentage point higher for the best high interest savings accounts.
Softening inflation is positive news as it means the value of someone’s savings will be eroded less quickly – though with the headline rate on a par with the best savings deals, it’s important to shop around or the return could still be negative.
What’s the outlook for inflation?
Forecasters agree that inflation, broadly, should continue to ease further in 2024. The Chancellor of the Exchequer, Jeremy Hunt, has already met a key government target of halving the inflation figure from an earlier high of 10% by the end of 2023. More generally, however, there is less consensus about the size and shape of the retreat.
What’s more, the latest annual CPI figure of 3.4% confirms that bumps in the road continue to dog the prospects for a smooth economic recovery.
What can investors do about inflation?
Faced with such a mis-match between savings rates and inflation, there are relatively few ways to preserve wealth safely, let alone help it to grow.
Investing is one option for savers looking to keep their money in line with – or beat – inflation. But this is a far from risk-free option, with the potential for loss of capital along the way.
David Henry, investment manager at Quilter Cheviot, says that, during periods of rising inflation, real assets such as stocks and shares, property and commodities, tend to perform better than cash or bonds: “In sterling terms, we looked at the performance of both UK and international stocks during periods of rising inflation since 1970 and found that UK markets tended to outperform global peers during these periods.
“This is most likely due to the UK market’s longstanding relatively high exposure to energy and commodity sectors. An obvious ‘hedge’ to the current cost of living crisis would be to hold shares in an energy producer.”
Charles Stanley’s Rob Morgan says: “Protecting against high inflation is difficult for investors. Higher inflation, and higher interest rates to curb it, has an adverse effect on most asset prices.
“The problematic scenario for investors is that a simplistic traditional portfolio of equities and conventional bonds is not inflation resilient.”
But he says there are a small number of areas that can help diversify a portfolio while helping to counter the effects of inflation. These include:
- Infrastructure assets which often generate revenues that are contractually linked to inflation rates.
- Index-linked bonds that pay an income, a component of which is inflation-linked.
- Gold which sometimes does well in inflationary times, especially where interest rates do not rise sufficiently to compensate for stubborn inflation.
As with any investment, these assets become commensurately more expensive if lots of investors have the idea of protecting their portfolios at the same time.
Save into a pension
Pension saving offers generous tax relief, which is applied to people’s contributions at their marginal rate of income tax. With so many strains on personal finances, those who can afford to top up their pension – even backdating payments by three years under a process known as ‘carry forward’ – would be wise to cash in while they can.
Alice Haine, personal finance analyst at Bestinvest, says: “Pension savers nearing retirement, who want to beat inflation over the long term and reduce their income tax liability in the process, could top up their workplace and personal pensions.”
“The raft of changes in the 2023 Spring Budget, which included scrapping the Lifetime Allowance and upping the Annual Allowance by 50% to £60,000, has given savers a window to boost contributions to workplace and personal pensions. This is a beneficial strategy when inflation and the tax burden are so high.”
