By GRAHAM FROST 20/04/2007
Both the UK and China were hit by inflationary woes this week. The Shanghai & Shenzhen 300 Index plunged nearly 5% on Thursday on the announcement that the Chinese Consumer Price Index (CPI) annual inflation figure for March was 3.3%, its highest level for over two years. Rising inflation has prompted fears that Chinese interest rate hikes could follow, potentially slowing economic growth.
Back at home National Statistics has announced that the annual CPI figure for March is 3.1%, while the Retail Price Index (which also includes housing costs) is 4.8%, its highest level since July 1991. With CPI passing the 3% mark Mervyn King, Governor of the Bank of England, was forced to write a watershed letter to Chancellor Gordon Brown explaining the reasons for this. Since 1997, the Bank’s Governor has been required to write an open letter whenever the CPI is more than 1% away from its 2% target, something that has not happened until now. Fortunately the UK stockmarket did not react in a similar fashion to China, but rising inflation does pose potential problems.
| "It’s now widely expected that the Bank of England will raise interest rates at its next announcement on 10 May." |
In the short term it’s now widely expected that the Bank of England will raise interest rates at its next announcement on 10 May. This would heap further misery on many homeowners, with the monthly repayments for a typical £250,000 repayment mortgage rising by around £50 or more. Of course, higher inflation does mean that the ‘real value’ of debt falls progressively quickly, but this will be of little consolation to those struggling to meet their mortgage payments.
Higher interest rates would also increase the attractiveness of the Pound to overseas investors, likely causing the Pound to further strengthen against the US Dollar; we’ve already seen the two US Dollars to one Pound barrier broken this week. While this is great news if you’re planning a holiday to the US or buy imported goods, it’s bad news for British exporters and UK investors with overseas investments.
Rising inflation has implications for savers too, as it increases the likelihood their savings shrink in real terms. With annual RPI of 4.8% a basic rate taxpayer would need to be earning 6% gross per annum on their savings to simply stand still net of inflation. For higher rate taxpayers the breakeven rate rises to 8% gross per annum. The going may be even tougher still if your ‘personal’ rate of inflation is higher than RPI. As the chart below shows, losing out to inflation is an increasing problem for savers.
In practice, it’s even worse than the chart suggests as few savings accounts match or exceed the Bank of England Base Rate. According to Moneyfacts the average rate on an instant savings account with £1,000 balance is currently just 3.34% gross per annum (the Bank of England Base Rate is 5.25%). That’s nearly 1.5% below inflation even before taking tax into account.
| "On the bright side, valuable tax-free allowances such as Cash ISAs and National Savings Index-Linked Certificates offer a solution." |
On the bright side, valuable tax-free allowances such as Cash ISAs and National Savings Index-Linked Certificates offer a solution. Some Cash ISAs currently pay in excess of 6% per annum while Index-Linked Certificates guarantee to beat inflation. For example, the 14th Issue three year Certificates pay RPI plus 1.15%, currently equal to 5.95% tax-free and the equivalent of 9.92% gross for a higher rate taxpayer.
Should interest rates rise next month then keep a beady eye on your savings accounts to ensure the provider(s) passes on the full increase. While banks and building societies are only too keen to hike mortgage rates in the wake of Base Rate rises, they’re strangely reticent when it comes to savings.