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Lessons from rising inflation and interest rates

As 2021 drew to a close, inflation finally forced the Bank of England’s hand. What will higher rates mean for you?

The November inflation figures, released in mid-December, once again exceeded the Bank of England’s (BoE) expectations. At the start of November, the BoE had said that CPI inflation was “expected to peak at around 5% in April 2022”. Six weeks later it changed its tune: “Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022”.

What does that mean to you?

  • The effects on your personal spending will fluctuate. Inflation is not constant across all goods and services. For example, November’s data showed that while overall inflation was 5.1% a year, in the health category prices rose only 1.4% across the 12 months, while for transport (for example those petrol prices and secondhand cars) the annual increase was 12.5%.
  • The buying power of your cash savings is depreciating fast. The Bank responded to the latest jump in inflation by raising Bank Rate from 0.1% to 0.25%. Viewed another way, over a year a deposit of £1,000 would earn £2.50 (before tax) in interest at Base Rate, while current inflation would erode its buying power by about £50.
  • Your next pay rise probably won’t cover the erosion of buying power. The Bank’s forecast of an April peak for inflation – primarily driven by the next Office of Gas and Electricity Markets (OFGEM) utility price cap rise – will coincide with the increase in National Insurance contributions announced last September. For example, if you earn £40,000 a year and, like many employees, your salary review takes effect in April, you will need a pay rise of 8.2% to maintain the buying power you had a year ago.
  • Your insurance cover will need a review. If you have life assurance and/or income protection that is not inflation-proofed, then you will need to increase the level of cover to maintain the real value of your protection. With buildings and contents insurance, that often happens automatically and goes unnoticed.
  • Any inheritance tax (IHT) liability on your estate has probably gone up. The current Chancellor has followed in the footsteps of his predecessors by freezing the IHT nil rate band. As inflation drives up asset values, such as your home, that could mean more of your estate is exposed to 40% tax.

The value of your investment and any income from it can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

Tax laws can change. The Financial Conduct Authority does not regulate tax or benefit advice.

Content correct at the time of writing and is intended for general information only and should not be construed as advice.

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