New figures released by the Office for National Statistics (ONS) show that the rate of inflation dipped for the second month in a row in December, suggesting the peak of the cost of living crisis has passed. The fall to 10.5 per cent last month from 10.7 per cent in November, indicates further steady easing back from the painful 41-year high of 11.1 per cent recorded in October.
Falling fuel costs were largely behind the slowdown in the pace of price rises, with the average petrol price down by 8.3 pence per litre month-on-month in December. However, there was little respite for families, with food and drink inflation soaring yet again, to 16.8 per cent in December up from 16.4 per cent in November, marking the highest level since September 1977.
But what does it all mean for your personal finances, mortgage, savings, pensions and general household spending over the next month? Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investment platform and coaching service, explains what to expect.
Commenting on the new inflation rate, Alice said: “Consumers cannot breathe a full sigh of relief just yet. Ultimately, high inflation is largely a result of global challenges such as supply chain constraints and geopolitical tensions and there are no guarantees of what lies ahead.
“However, with the Bank of Englsnd likely to continue its rate hiking cycle despite recession fears, mortgage costs significantly higher than a year ago and households already slashing expenditure to keep costs down, inflation is likely to continue easing from here.”
Household budgets
Alice explained that double-digit price rises will still deliver a blow to disposable incomes. She said: ‘High inflation has a corrosive effect on the real value of cash as it erodes purchasing power and eats into savings, forcing households to make spending cutbacks that will of course have consequences for many businesses too.
“Throw in higher borrowing costs, a rising tax burden and falling real wages - a driver of the intensifying industrial action - and most households won’t be feeling the benefits of an easing inflation rate just yet. Instead, careful budgeting will remain a priority for now as they strive to keep everyday costs in line.”
She added: “Living within your means, drawing up a solid budget you can stick to and doing an audit of your regular payments and subscriptions will all help to identify overspending patterns to ensure finances can stay robust in the long term as well as the short term.”
Mortgages
With interest rates currently at 3.5 per cent and expected to jump again at the Bank of England’s next monetary policy meeting in February as the battle against price and wage growth persists, mortgage rates are perilously high when you compare them to the past decade.
Alice said: “With lenders now actively slashing the cost of deals as they compete for new business, the hope is that rates will continue to drop from here. Borrowers that have already locked in a new product in recent weeks for an upcoming mortgage should contact their broker or provider to negotiate a fresh deal.
“Borrowers must also remember that with inflation still in the double digits, affordability will remain an issue both for first-time buyers and those looking to remortgage. A higher cost of living hurts disposable incomes, something lenders examine carefully when assessing a borrower’s creditworthiness."
This will also have a knock-on effect on house prices. Alice explained: “It means first-time buyers may not be able to borrow as much as they could a year ago, while those looking to refinance at a time when house prices are expected to slide may find their loan-to-income ratio is adversely affected.”
Some 1.4million fixed rate mortgage deals are set to expire this year, which means many homeowners will face much higher mortgage repayments when they sign up for a new offer - even with falling rates - unless they have been able to overpay in the run-up to the end of their deal.
Savings
Savings rates have risen significantly in recent months, reflecting interest rate rises, but with inflation still high, any real return will still be deeply negative.
Alice explained: “Double-digit inflation has a devastating effect on people’s savings pots, as it erodes the value of that money. Even with the top easy-access accounts now at 2.9 per cent, fixed accounts at 4.56 per cent and regular savings at 7 per cent, the real return will still be negative.”
Pensions
High inflation is always a blow for retirees looking to maintain their purchasing power, particularly those solely dependent on the State Pension who have a fixed amount to spend each month. The good news is that State Pension payments will go up by 10.1 per cent from April, hopefully coinciding with a period when the pace of price rises eases further.
For now, retirees on lower or fixed incomes will find their money does not stretch as far, and some pension savers may be tempted to reduce or stop pension contributions altogether as they prioritise rising living costs instead - leaving some at risk of a pension shortfall in their retirement years.
However, Alice warns against doing this, she said: “Money directed towards pensions and investments can counteract the damaging effects of inflation over time, particularly for young savers, thanks to the compounding effect over the long term and generous state tax reliefs.
“For pension savers looking to boost their retirement income, now would be a good time to increase pension contributions. That’s because any money invested in a pension not only benefits from the beauty of compounding over the long term, but also protects against income tax (which is on the rise thanks to frozen tax thresholds) because tax relief is applied to pension contributions at their marginal rate of income tax.”
Those on the brink of retirement who are worried that high inflation will erode any income they take from their pension pots could also consider buying an escalating annuity - a type of contract that offers a guaranteed income in retirement, which increases over time to keep up with inflation.
Alice explained: “Annuities have been deeply out of favour for many years, due to the low rates available amid the era of cheap money, with most retirees choosing to stay invested and draw an income from their pension pot instead.
“However, gilt yields rose significantly last year which has also driven up annuity rates. For some retirees, a blended approach towards retirement of both purchasing an annuity to cover basic costs, alongside drawdown on the rest of their pension pot can be the right one.”
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