Inflation Expected to Rise to 7.1%: What It Means for Your Money
Inflation is forecasted to increase to 7.1%, according to economists, when the official statistics are released this week by the Office for National Statistics (ONS). This rise in inflation can be attributed mainly to higher fuel prices. The previous month’s inflation rate was around 6.8%, and if this forecast is accurate, it will pose challenges for individuals struggling with the cost of living, casting doubt on Chancellor Rishi Sunak’s pledge to halve inflation by the end of the year. Let’s explore why inflation is set to rise and how it will impact your finances.
Why is inflation expected to increase?
Inflation has experienced a significant decline over the last few months, dropping from 10.1% in October of the previous year to 6.8% in the last month. However, experts predict that this trend may come to an end with the upcoming release of August’s data. Ashley Webb, an economist at Capital Economics, explains that a 4% month-on-month increase in petrol prices in August compared to a 6.8% fall last August is likely the cause for this anticipated rise in inflation. Nonetheless, the organization still expects core inflation (excluding volatile price increases such as energy, food, alcohol, and tobacco) to fall from 6.9% to 6.7%, along with a decrease in services inflation.
Impact on interest rates
Inflation plays a crucial role in determining whether the Bank of England will raise or lower the base rate. The base rate, currently at 5.25%, influences the cost of borrowing for banks. When inflation rises, the Bank typically increases interest rates to curb spending and reduce demand for goods and services. Governor of the Bank of England, Andrew Bailey, has suggested that interest rates may be near their peak. However, economists believe that if inflation rebounds, the Bank may raise interest rates from 5.25% to 5.5% in its upcoming rate determination. Nevertheless, if core and services inflation continue to fall, this rate hike may be the last in the current cycle.
Impact on mortgage rates
Inflation can affect mortgage rates due to its impact on interest rates. Tracker mortgages, which follow the base rate set by the Bank of England, as well as standard variable rate mortgages, can be immediately affected by the inflation figure. If inflation decreases, the likelihood of a higher interest rate rise and an increase in mortgage rates decreases. However, if core inflation and services inflation rise, there is a greater chance of mortgage rates going higher. Fixed-rate mortgages are not immediately affected by changes in interest rates, as their rates are determined by long-term borrowing trends rather than specific rate increases.
According to Nick Mendes of brokers John Charcol, if current forecasts hold and there is one more interest rate increase to 5.5%, borrowers can expect lenders to continue sporadically repricing downwards. This trend may lead to rates around 4.5% by the end of October. However, higher-than-expected inflation could disrupt this downward trend, potentially resulting in slower rate decreases.
Effect on savings
While a higher base rate resulting from increased inflation may lead to banks offering higher interest rates on savings accounts, inflation itself erodes the value of money held in the bank. Inflation is currently nearly 2% higher than the best-paying easy access savings accounts, meaning the real value of savings decreases each year. Falling inflation can help mitigate this impact if savings account interest rates remain the same.
Impact on food prices
Inflation encompasses various goods and services, including food prices. Although overall inflation has been declining, food inflation has been higher than average price rises. In July, food inflation stood at 14.9%, but it fell to 12.7% in the four weeks leading up to August 6th, according to analysts at Kantar. However, falling food inflation does not equate to decreasing food prices. Instead, it indicates that food prices are increasing at a slower rate than before.
Effect on pensions
Higher inflation negatively affects individuals with pensions, as it diminishes the spending power of their savings over time. When inflation falls, this effect is lessened. For example, if you have a pension pot of £87,500 and inflation runs at 10% in a year with a 5% investment growth, the nominal value of your pot may be £91,263. However, adjusted for inflation and expressed in today’s money, the real value of your pot would be approximately £83,650. Therefore, falling inflation can mitigate the impact on pension pots and their future purchasing power.
In conclusion, the anticipated rise in inflation to 7.1% will have significant implications for consumers and the overall economy. While interest rates and mortgage rates may increase, savers may find it challenging to maintain the value of their savings. Food prices are expected to remain relatively high, and the impact on pensions will depend on the rate of inflation. It is essential to stay informed and review your financial plans accordingly to navigate these changing economic conditions.