Inflation Update: January Figures Show a Rise
According to the latest statistics released by the Office for National Statistics (ONS) on Wednesday, inflation has risen to 3 percent for the year leading up to January. This Consumer Prices Index (CPI) measure of inflation surpasses the Bank of England’s target of 2 percent and indicates an increase from the previous figure of 2.5 percent reported for the year ending in October. While economists had anticipated a rise, estimating the figure to be around 2.8 percent, the actual inflation rate, although elevated, remains significantly lower than the peak of 11.1 percent recorded in October 2022.
Future Inflation Outlook
The outlook for inflation suggests a continued upward trend over the next year. In October, the Office for Budget Responsibility (OBR) projected that the upcoming October Budget would contribute to a rise in inflation. This is partly due to the expected transfer of increased employer national insurance contributions to consumers, resulting in higher prices. The Bank of England has forecasted that inflation could reach approximately 3.7 percent by the third quarter of 2025. Moreover, it is predicted that inflation may exceed 3 percent even sooner. For instance, Pantheon Macroeconomics anticipates inflation could peak at 3.4 percent as early as April.
Implications for Interest Rates
The increase in inflation often leads to a more rapid rise in prices, which can influence the Bank of England to maintain higher interest rates for an extended period. Currently, interest rates stand at 4.5 percent following a reduction earlier this month. Despite the rising inflation, many analysts predict multiple cuts to interest rates later this year. This expectation is based on the belief that inflation will decline in the long term, coupled with a sluggish economy characterized by only marginal growth projections for the year. Sustained higher interest rates could further hamper economic performance.
Impact on Mortgages, Savings, and Pensions
Mortgages
While mortgages are not directly influenced by inflation, the Bank of England’s base rate, which inflation affects, plays a crucial role. Products such as tracker mortgages and standard variable rate mortgages adjust directly in response to changes in interest rates. Therefore, if interest rates rise due to increased inflation, borrowers on these deals will experience a corresponding increase in their mortgage rates. Conversely, fixed-rate mortgages are often based on long-term predictions about the base rate. A significant decline in inflation may prompt a decrease in mortgage rates, as experts would likely anticipate a drop in the base rate in the near future. Although rates have shown volatility in recent months, most analysts expect them to decline over the course of this year, contingent upon expected reductions in interest rates. The latest inflation figures are unlikely to exert a substantial impact on mortgage rates.
Savings
High inflation poses challenges for savers as it diminishes the purchasing power of money held in savings accounts. Consequently, lower inflation rates are generally more favorable for savers. The influence of inflation on the Bank of England’s interest rate also significantly affects savings rates. Experts believe that we may have already surpassed the peak for savings rates, with many fixed rates now falling below 5 percent. Therefore, it is advisable to take advantage of the most competitive deals currently available. Presently, the top easy-access account is a cash ISA from Trading 212, offering an attractive rate of 5.03 percent.
Pensions
The recent decline in inflation is likely to be welcomed by pensioners who have faced the financial strains of the cost of living crisis over the past two years, particularly those reliant on the state pension for a significant portion of their income. Elevated inflation can erode the value of pension savings, making it a critical issue for retirees. Additionally, it is essential to consider the effect of inflation on annuity rates. Annuities provide a guaranteed annual income during retirement and serve as an alternative to withdrawing money from a pension pot, which may deplete over time, especially if retirees live longer than anticipated. Although annuities have been less popular in recent years, rising interest rates have enhanced the potential annual income that can be secured through them. However, retirees considering this option should act swiftly; with the Bank’s recent interest rate cuts, annuity rates may soon begin to decline.
