The latest price inflation figures show a leap in the rate of the Consumer Prices Index (CPI) to 3.7% in the year to December 2010.
This is compared to a rate of 3.3% for the year to November.
There was a more modest rise in the Retail Prices Index (RPI), from 4.7% to 4.8%. RPI includes mortgage and housing costs.
We expect price inflation to peak at a slightly higher level than this over the next few months, as the VAT rise from the start of this month feeds into the system.
Higher fuel prices will also push up inflation in the short term.
However, we share the view of the Bank of England that inflation will start to fall after this as spare capacity in the economy starts to bring down prices. For this reason, we maintain our belief that the Bank will not start to raise interest rates just yet in order to bring this temporary rise in inflation under control.
This is little comfort for savers, who are experiencing capital erosion due to the combination of historically low interest rates and higher than target price inflation.
The average interest rate available on an instant access savings account is 0.23%, so savers with this rate of interest have seen capital erosion of 4.57% over the past year, using the RPI measure of price inflation.
Capital erosion is even more severe once income tax on savings interest is taken into account.
Savers face a tough choice this year – whether to stay with the relative security of cash savings but experience further capital erosion due to inflation, or expose some of their capital to risk with the aim of achieving ‘real’ returns over the medium to long term.
It’s a difficult decision to make and we would encourage anyone who faces this dilemma to seek professional independent financial advice from an adviser who is not financially motivated to invest your cash savings, but can consider cash on equal terms with other investment options.
Do speak to us if you need impartial advice on this or any other investment-related matter.
