UK inflation continues to rise, putting a squeeze on households and gnawing away at savings

Jason Hollands, Managing Director of Bestinvest, the online investment service comments on the latest UK Consumer Price Index inflation figures released today:

“The latest UK inflation data, released this morning by the Office for National Statistics, has revealed that Consumer Price Index inflation rose to 2.5% in the 12-months to June, up from 2.1% in May, with the largest contribution coming from transport costs. This was ahead of consensus expectations and comes a day after it was revealed that US CPI inflation had rocketed to 5.4%.

“That prices are continuing to rise as economies bounces back from last year’s brutal contraction is little surprise, especially when there are supply bottlenecks that have built up during the lockdowns. Where the jury remains out though is whether the surge is a temporary effect or could lead to a more persistent problem if economies are allowed to overheat fuelled by unprecedented levels of both monetary and fiscal stimulus.

“For now, both the Bank of England and the US Federal Reserve are messaging that they see rising inflation as a ‘transitory’ phenomenon. The Bank of England’s rate-setting Monetary Policy Committee has said it expects UK CPI inflation to rise above 3% ‘for a temporary period’ before receding next year.

“Yet it is notable that the Bank of England’s outgoing chief economist, Andy Haldane, broke ranks with this calming tone a week ago to warn that inflation was on course for 4% - double the Bank of England’s long-term target rate - and that ‘as aggregate excess demand emerges in the second half of the year, I would expect inflation to rise, significantly and persistently’.

“Ultimately investors will form their own view. Most recently central banks have endeavoured to calm down concerns about persistent inflation, but if government bond yields start to rise again – as they did at earlier in the year – it will be a sign of renewed concern. When investors decide inflation is a problem, government bonds with low yields get dumped, as investors need higher returns to keep ahead of inflation.

“Whether inflation is here to stay or gone tomorrow so to speak, remains to be seen. But in the near term elevated levels of inflation are going to put a squeeze on many people’s household budgets at the very point they are starting to get out and about more, including returning to places of work.

“For some, additional savings built up during the pandemic will provide a buffer against higher prices over the coming months. Around 30% of household are estimated to have accumulated additional savings during the pandemic as a result of many months of restrictions on socialising and travelling and the reduced costs of working from home. But rising inflation now risks eating into those improved finances, gnawing away at the future spending power of cash left languishing in savings accounts at a time of ultra-low interest rates. Don’t be fooled by small rises in cash savings rates: real interest rates on cash savings are negative, once inflation is taken into account.

“While it is very wise to have some cash set aside for short term needs and unforeseen emergencies, holding too much wealth in cash for prolonged periods when the bogeyman of higher inflation is stalking the earth is a sure way to get worse off in real terms. I would therefore urge people with savings and investments, to think carefully about whether they have the right mix between savings and longer-term investments with the potential to deliver inflation-beating returns. For investors, the current climate of low interest rates but above trend inflation continues to favour equities over bonds.”