We won’t mince words. Inflation has become the financial demon of the moment. Although it isn’t quite as severe as the 24% in the 1970s, it’s starting to cause havoc on many household finances. Rising energy costs and rising food prices are taking their toll on budgets. 

Last week, the cost of living notched up to 4.2 per cent in the year to October – compared with 3.1 per cent in the previous month and above the 2 per cent target set by the Bank of England. 

This means that inflation has reached its highest point in nearly 10 years and it is likely to continue rising over the coming months. It has been suggested by the Bank of England that inflation could reach 5 per cent next spring, before dropping back. The Bank of England believes it can go higher.

Heating up: Inflation is the new financial demon in the room

Heating up: Inflation is the new financial demon in the room

Roger Clark, partner in wealth management firm The Private Office, says that “inflation of 4.2% is concerning”. ‘Yet it hardly represents a return to the bad old days of the 1970s and 1980s when inflation was constantly in double digits – and some employees received monthly pay increases to help combat it. 

‘Nevertheless, households will be focusing on this metric for the first time in years – and searching for ideas to keep their finances in order and their savings from being devalued.’ 

Clark states that inflation is destructive in its own right and can lead to lower savings rates, which in turn drives up household costs. But what’s more frightening about the present situation are the demons in the wings. 

One is higher interest rates. Although they are most likely to rise in December given the fact that the Bank of England resisted the temptation to hike the base rate by 0.1 percent this month, it may not be as aggressive and delay any increases in the New Year. 

The fact that savings rate are increasing suggests an imminent increase in the base rate. Bad news for homeowners whose mortgages are linked to variable – rather than fixed – interest rates. Goodish news for savers, though they will still be unable to find any savings account that comes anywhere near paying 4.2 per cent interest – the rate necessary to ensure the ‘real’ value of their cash deposits are not eroded by inflation.

There is another demon in the undergrowth. It’s particularly nasty. To pay for Government’s “reform” of social care, and the relaunch of the National Health Service, April will see taxes rise.

The 1.25 percentage point increase in National Insurance Contributions – and corresponding increase in tax on dividend income – will eat into many households’ income. 

Personal allowances will not be increased to offset these tax increases (Chancellor of Exchequer Rishi Panak already shared this bad news). 

The Institute for Fiscal Studies (IFS) has spelt out the impact of these demons on household income – and it doesn’t make for pleasant reading. Someone on a salary of £30,000 will need a pay rise of 7.1 per cent in the year to April 2022 to maintain the standard of living they currently enjoy. It is hard to imagine that many employers are able to award such awards, especially when they face tough business decisions. 

According to the IFS, all households will feel the financial pinch regardless of their income. However, it recognizes that low-income families would be most affected by any sharp rise in energy prices in April. 

Those on benefits, including the state pension, will also struggle as the 3.1 per cent increase due in April will fail to make good the corrosive effect of inflation – then possibly running at five per cent. 

This is a fact that former Pensions Minister Baroness Altmann has not forgotten. Last week, Altmann failed to convince the government to reconsider its decision to end the triple-lock guarantee on state pensions. She says the 3.1 per cent increase will ‘plunge more elderly people into poverty’. What can we do to combat the inflation curse against the backdrop of rising interest rates? 

Quite a lot, especially if you’re a mortgage borrower, someone who is keen to grow their long-term wealth and happy to take on board investment risk – and don’t mind going through bank and credit card statements checking whether any costly monthly subscriptions ought to be cancelled.

Fixing rates can be done by homeowners now 

While most homeowners took advantage of record low mortgage rates in recent years to reduce their monthly interest, others have not. Many borrowers will also be ending their fixed deals. For those still on a standard variable rate – typically anything between 3.5 per cent and 5 per cent plus – it now makes sense to move on to a fixed rate before the base rate rises. 

Ray Boulger is a John Charcol mortgage expert. He says that consumers can’t do much to lower the price of gas, electricity, and petrol/diesel they use in their cars. However, many people can reduce their mortgage payments. 

David Hollingworth, of broker L&C Mortgages, urges prompt action. His words are: “Lenders have been consistently nudging up fixed-rate prices on new loans, and remortgage transactions. They are still very attractive because they allow borrowers to lock down the lowest rate for their largest household expenses. 

The best remortgage deals, he says, are currently 0.99 per cent for a two-year fix from building society Monmouthshire, based on a loan-to-value of up to 75 per cent – and 1.34 per cent, fixed for five years, from Nationwide (loan to value up to 60 per cent). So, taking a repayment loan of £150,000 with 20 years remaining, someone on a standard variable rate of 3.59 per cent would pay £877 a month. On Monmouthshire’s rate, the payment comes down to £689, saving £188 a month. Nationwide’s five-year fix would cost £713, saving £164 a month. 

A fixed-rate loan with a lower interest rate can be obtained for those who have less than six months left on their mortgage. This will allow them to continue paying the current agreement until it ends. Boulger predicts that a fixed-rate loan obtained now will be attractive in one year. These are wise words.

Better deals should be available to Savers 

Everybody should have cash reserves for unexpected events, such as a boiler breaking down or losing their job. 

Experts consider three months worth of household expenses prudent. For those who are saving for big purchases such as new cars or holidays, cash savings can be a good option. But these savings are currently dwindling in real value terms because the interest you get will come nowhere near the current inflation rate of 4.2 per cent. These two messages are important. 

First, savers should not oversave – a message the Financial Conduct Authority is desperate to get across. 

The second is that savers must continue to shop around for the lowest rates, regardless of whether this slows down the inflationary impact. 

Anna Bowes co-founder Savings Champion rate examiner, said: “If your money has 0.01 Percent interest and inflation is 4.2 percent, then its real value will fall in 16 years. It will drop by half if you change to an easy-access account that pays 0.67 percent. Switching doesn’t erase the inflation damage to savings. A Bank of England rate hike will only close the gap between savings and inflation. In the last few days, rate rises from NS&I (on its popular income bonds that pay monthly interest) and RCI Bank (on its latest batch of fixed term accounts) suggest a better savings environment is around the corner. However, the rate hikes aren’t anything to shout about.

Do you have spare cash? Then invest it 

All cash not used to meet a financial emergency, or for a savings goal should be put into the stock market. 

Alex Shields of The Private Office is a chartered financial professional who believes shares are a better way to get a longer-term return than inflation. 

But he cautions: ‘If you choose the investment route, it is important you are comfortable with the bumps in the road associated with investing – bumps which can be a shock to those used to savings accounts where the capital value does not fluctuate.’

He suggests that Investing is easiest through tax-friendly packaging such as an Individual Savings Account (ISA) or a pension. For those stocks in the UK stock markets that are likely to prosper due to higher inflation or lower interest rates, financial stocks will do well. 

Banks can earn greater profits by lending, while asset managers gain from money being moved out of cash to investments. Artemis UK Select invests 34% of its portfolio in financials. 

Gold and other commodities can also be used as a hedge against inflation. Dzmitry Lipski, wealth manager Interactive Investor’s head of funds research, said fund WisdomTree Enhanced Commodity gives investors ‘a wide and diversified commodity exposure’, which includes industrial metals as well precious metals.

Switch providers for lower household bills 

Even though switching has been halted by the seemingly inexorable rises in energy costs and subsequent collapse of some suppliers, there are still savings opportunities for households. 

Interactive Investor’s Myron Jobson says that many people will continue to pay monthly fees for services they don’t use or need. They might not lead to big savings per month but will “add up over the long-term,” he said. 

He also urges households to see if they can get a cheaper broadband deal – especially if they have just come off a special introductory offer. 

Those nearing the end of a mobile phone contract should shop around – and consider cheaper alternatives such as keeping an existing phone and taking out a cheap SIM cardonly deal. Sites like Uswitch will help you find the best deal. 

Low-income pensioners older than the state pension age should verify their eligibility for pension credit.

This benefit can pave the way for a free TV licence and the warm home discount scheme which knocks £140 off your electricity bill. See gov.uk/pension-credit 

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