Rising inflation: What does it mean for you?

Published: March 24 2009 12:08 | Last updated: March 24 2009 12:08

Inflation staged a surprise rise in February for the first time in five months. Prices, as measured by the consumer price index, rose to 3.2 per cent in the year to last month, up from 3 per cent in January.

However, another measure, the retail price index, which includes housing costs showed that inflation had fallen to zero.

So are prices still rising or not?

The price of consumer goods is still rising faster than the Bank of England’s 2 per cent target. There was a sharp rise in food prices in February, while fuel prices also increased after a sustained period of sharp falls.

Mervyn King, governor of the Bank of England, said the price rises came as a result of the sharp depreciation in the value of sterling. A weaker exchange rate means cheaper international commodities such as oil and food are not being fully passed on to British retail prices.

The RPI is falling faster because of the recent sharp drop in mortgage costs.

I thought we were heading for a period of deflation?

Economists still expect consumer prices to fall in the coming months. IHS Global Insight said there would be greater pressure on retailers to price competitively as consumer spending waned and believed companies would see their pricing power diminished. Also, oil and commodity prices are likely to fall sharply. Howard Archer, chief European and UK economist at IHS, said these factors should outweigh the inflationary impact of sterling’s marked depreciation.

What does this mean for my savings and investments?

With interest rates close to zero, rising inflation means many savers could see a negtive return on their savings.

In order to offset the effect of taxation and inflation, basic rate taxpayers now need to earn 4 per cent on their cash in order to preserve the spending power of their money. Higher rate taxpayers need to achieve 5.33 per cent.

But after six consecutive rate cuts from the Bank of England, banks and building societies have trimmed back their interest rates, and the majority now pay out less than 1 per cent to savers.

The best cash rates on the market are currently 4.18 per cent for a two year bond from ICICI, available only to those with at least £1,000 to invest.

Savers have been advised to use their £3,600 tax free Isa allowance before the end of the tax year on 5 April. Average rates for cash Isas have risen in the last few weeks as providers compete for money. Savers with Leeds Building Society can earn a fixed rate of 3.5 per cent of their money provided they leave it untouched for five years, according to Moneynet.co.uk.

But if inflation falls in coming months people relying on cash savings, such as pensioners, could see their income go further.

Does inflation mean mortgage rates will start rising?

Possibly. If the inflationary figures turn out to be a one month aberration, then mortgage rates are expected to continue to fall. But if not, then we might have seen the bottom of the mortgage market. However rates are not likely to rise fast any time soon as there is still a significant risk of an extended recession.

“It’s very difficult for home owners to get it right,” said Ray Boulger at John Charcol, the broker. “The big unknowns of how far interest rates will come up by in the future, and when this will happen, mean borrowers may get comfortable paying low rates and have a shock when rates start to rise again.”

Brokers recommend fixing mortgage rates now rather than hoping for further rate cuts and opting for longer-term rather than two-year deals. Five-year deals may be slightly more expensive but customers who fix for two years risk coming out of a deal at a time when interest rates are rising again.

Abbey and HSBC offer five-year deals below 4 per cent for those looking for a maximum loan of £250,000 and Accord Mortgages, a subsidiary of Yorkshire Building Society, has a five-year fixed rate of 4.29 per cent for loans of up to £750,000. However this is available only to those borrowers looking for a loan worth 60 per cent of the value of their property.

Am I now more likely to get a pay rise?

IHS Global Insight said pay awards tended to be linked to retail price inflation so the flat year-on-year level would maintain the downward pressure on wages. “As a result, many workers are likely to wage freezes or even pay cuts,” said the group.