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Lessons from rising inflation & interest rates

Lessons from rising inflation & 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 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, and the tune has changed: “Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022”.

CPI Inflation since 2010Source: ONS

So, what does this mean for 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 (eg: 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 around £50.
  • Your next pay rise probably wont cover the erosion of buying power. The Bank’s forecast of an April peak for inflation – primarily driven by the next OFGEM utility price cap rise – will coincide with the increase in National Insurance contributions announced last September. Eg: if you earn £40,000 per 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 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.
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