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What does a fall in inflation mean for you?

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17/12/2013
There was good news for consumers this week after official figures revealed that the UK's headline inflation rate fell to 2.1% in November, its lowest level in four years.

Consumer price inflation dropped from 2.2% the previous month, falling ever closer to the Bank of England’s 2% target – the first time it has been so close in 48 months – giving consumers more spending power.

However, the good news may be fleeting as recent price hikes by the ‘Big 6’ energy firms were not accounted for in the Office for National Statistics (ONS) data.

Jeremy Cook, chief economist at the foreign exchange company, World First, said: “Continual falls in energy and food prices seem to remain the main drivers – oil price falls were the main cause of the 1.0% slip seen in factory gate prices, when compared to this time last year.

“However, this good news may not last too long given the increase in utility costs that are to hit the basket next month courtesy of recent price rises by energy providers.”

Why does inflation matter?

Although the inflation rate has fallen, it is still above the Bank’s 2% target. One of the big dangers of high inflation is that it has a regressive effect on incomes, especially the incomes of older people and lower earners.

These households tend to be on fixed incomes, and when prices rise, they can afford to buy less and less with their limited incomes.

Over the past few years, soaring energy costs has driven hundreds of thousands of these vulnerable people into fuel poverty – a situation where more than 10% of a household’s income is spent on meeting fuel bills.

What the news means for retirees…

High inflation is a particular hazard for the retired generation who often have less scope to adjust their income and expenditure. This group feels keenly any rises in prices as their fixed income means they have to make drastic cuts to get by.

The actual value of their savings pot decreases despite having the same number of pounds sitting in the bank. This is referred to as ‘real value’.

This week’s news means these pots of money are now worth more; however, experts warn that while inflation has gone down, it still remains a threat.

Vanessa Owen, LV= head of annuities and equity release says: “With the rate of inflation approaching the Bank of England’s target of 2%, this is certainly positive news for those worried about the rising cost of living.

“However inflation remains a significant threat to a comfortable retirement and many still overlook the real impact. Even at 2.1% inflation, many pensioners will see their disposable income greatly reduced over the course of their retirement. Particularly as the ‘Silver Inflation’ rate, as inflation for the retired population is often labelled, is generally higher than overall CPI.

“Retirees today have far more choice about how to structure their income in retirement, and many of the options can provide an element of inflation-proofing, yet the majority of annuities sold today are still on a level basis.”

Owen advises that people nearing retirement look around for alternative solutions such as investment linked annuities, fixed term annuities or drawdown.

She adds: “With people spending longer in retirement it is important that they purchase a product that ensures them the best possible income over the long term as the choices they make will impact them for years to come.”

What the news means for savers…

The ONS figures were also good news for savers: lower inflation means that those still sitting on cash will see the value of their pot increase by a few percentage points than if inflation were higher.

In the past few years, due to high inflation and low interest rates paid out by banks, savers have seen the real value of their savings pot get eroded.

As interest rates on many savings accounts are lower than inflation, they too fall behind rising prices, and people who rely on interest from their savings have been feeling poorer.

Real interest rates for millions of savers have been negative for over three years and as the Bank of England base rate, which has been at 0.5% since March 2009, is unlikely to increase any time soon, savers face more months of low savings rates.

This deters people from saving which can leave them vulnerable to financial shocks down the line.

Savers are advised to frequently review their savings account to check they are getting the best rates on the market.

Investors can protect their savings from the effects of inflation by investing in a range of assets which are able to grow faster than inflation. Gold has long been a traditional hedge against inflation, and equities are being tipped to continue to enjoy this year’s bumper returns into the New Year.

 

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