Households need to brace for a prolonged period of high inflation and further interest rate rises. The Governor of the Bank of England, Andrew Bailey, has warned that he will take forceful action to tackle inflation, already running at 9.4% and forecast to hit double figures later this year. He defended the decision last week to raise interest rates, saying there is a "real risk" of soaring prices becoming "embedded". Interest rates rose to 1.75% - the biggest rise in 27 years - with inflation now set to hit more than 13%. The UK is forecast to fall into recession this year, with the longest downturn since 2008 predicted. Increasing interest rates is one way to try to control inflation as it raises borrowing costs.
Inflation is a problem for most of us. Savers find that
the value of their cash is being rapidly eroded. At 10% inflation, the £100 you
save today will only buy £90 worth of goods in a year’s time. Many people find
that their household budgets are stressed. And even borrowers, who might be
expected to benefit from inflation, suffer when inflation triggers increases in
interest rates. So what can you do to protect your finances and combat
inflation?
1.
Protect your retirement income.
Inflation has an enormous impact
on how long retirement savings will last. The income that seems more
than adequate when your start your golden years can look less than generous
after 10 years of inflation, and a recipe for misery after 20. A
basic level annuity will mean having the buying power of your income eroded
every year. An inflation-linked annuity will start off providing a much
smaller income, but one that keeps increasing over time. A drawdown pension –
where your pension pot remains invested and you draw down an income as you need
it – is more flexible. However, you will still need to take care to avoid
running out of cash.
2.
Avoid locking your cash savings
away.
Savers should benefit when higher
inflation leads to the Bank of England increasing the Bank Rate. But beware –
although the rates offered by savings providers are rising, they have not yet
done so enough to come anywhere near inflation.
However, with the Bank
Rate forecast to rise further and with savings deals forecast to follow,
there could be better deals to be had over the next few months. Shop around for
the best deal and avoid locking your savings into a long-term deal because it
could mean missing out on much better rates in the near future.
3.
Look at your investment strategy.
In an inflationary world,
investing – where your cash is used to buy something which could appreciate in
price – could be more rewarding than saving.
While inflation erodes the value
of cash savings, it actually works to boost the value of some investments. But
how should you invest? Bond investment becomes less attractive in times of
inflation, as the income provided by bonds is subject to inflation.
Investors can protect themselves
by buying index-linked bonds, where the interest paid rises in line with
inflation. Some business sectors will suffer during inflationary periods. Oil
and mining companies, however, tend to do well as rising commodity prices are
good for their bottom lines. Utility groups often pay dividends linked to
inflation. However, inflation could be bad for others such as retailers and
supermarkets, which may lack the ability to increase prices. Luxury goods
may be shunned when households tighten their belts.
4.
Secure a low-rate mortgage before
rates rise.
Inflation has already triggered
rate rises, and mortgages are substantially more expensive than they were last
year. This process could continue – the Bank of England has hinted as much. To
avoid increasing interest costs, which could mean that buying your home becomes
difficult or even impossible, it makes sense to secure the lowest rate you can,
fixed for the longest possible period.
5.
Get some expert help.
Managing money in inflationary
times can be challenging, but the challenges can be much more manageable if you
have an expert to call. Talk to your financial adviser, or if you don’t have
one, see: Choosing a financial adviser | MoneyHelper
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