Old foe from the 1970s raises its ugly head again... inflation - Sarah Coles

Just when we thought we had enough anxiety to be getting on with, another potential risk is raising its ugly head: people are starting to worry about the return of inflation.
Sarah Coles is a personal finance analyst at Hargreaves LansdownSarah Coles is a personal finance analyst at Hargreaves Lansdown
Sarah Coles is a personal finance analyst at Hargreaves Lansdown

Right now, with inflation below 1 per cent, and the Office for Budget Responsibility predicting a slow return to 2 per cent, inflation veterans of the 1970s could be forgiven for dismissing the fears as ludicrous.

It’s like spotting a robin on the birdfeeder and going into meltdown over a potential Hichcockian nightmare.

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But while this could be a low point for inflation, there’s a strong argument it’s on its way up.

One of the most important factors is the money the Government has been pouring into the economy. It’s borrowing more than ever during peacetime and in 2020 spent an estimated £280bn on the crisis, including over £45bn on furlough alone.

The UK is not alone in this. One of the reasons inflation is such a hot topic is that Joe Biden announced plans for a $1.9 trillion relief package earlier this month. The theory is this cash works its way through the economic system and once you have more money chasing the same number of goods you get price rises.

The other side of the equation is that this money isn’t necessarily chasing the same number of goods.

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The virus has hit supply chains and created bottlenecks. The pandemic has brought destocking and websites selling everything from building supplies to white goods are having to list products as “awaiting delivery”.

While restrictions keep people from shopping, this doesn’t necessarily feed into price rises. However, when restrictions are lifted and life returns to anything even vaguely resembling normality, we’re likely to see a boom in demand - so more money will be chasing fewer goods and services.

Take air travel, for example, after vaccination, an overseas holiday might be first on your to-do list, but airlines have slashed flights dramatically, so with more people competing for fewer seats, you’re going to pay more for your trip.

The other major factor keeping a lid on inflation has been a depressed oil price. As soon as we start shopping, travelling and manufacturing at pace again, this is likely to begin rising, and we’ll see it feed fairly quickly into more inflation.

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All this comes at the same time as the end of the Brexit transition period. The fact that a deal was struck means we won’t see the tariff rises threatened by a no-deal Brexit, but the London School of Economics still estimates that the additional logistical difficulties will add 4.7 per cent to the price of unbranded products from the EU.

Predicting the level of inflation that’s on the way is notoriously difficult, but inflation has barely peaked above 5 per cent for the best part of 20 years, so any price rises could come as a nasty shock.

The problem with inflation is that it happens every day, while pay rises tend to happen on an annual basis (if at all), so there’s a big delay between prices rising and our income increasing to cope. It means we all face a bigger struggle to make ends meet. This tends to be particularly difficult for people on low incomes, especially when price rises focus on those things that dominate their budgets – like food and drink and household bills.

For those on fixed incomes, the damage is even more dramatic. This can include retirees who have annuity payments that aren’t linked to inflation, who see their income becoming less and less valuable, and there’s nothing they can do but cut back.

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And to add insult to injury, rising inflation is likely to push your tax bill up too. VAT is based on prices, so the more something costs, the more VAT there is to pay. And if wages rise to keep pace with inflation, this means more income tax and national insurance.

If you have savings, unless you have an interest rate higher than inflation, your cash is losing spending power every day. There’s an argument that inflation could encourage interest rate rises, which would help savings keep pace, but the Bank of England is going to be very wary of raising rates until an economic recovery is well underway.

For borrowers, eventually inflation could do them a favour, because it erodes the value of their debt. However, if rates rise, then the short-term pain can be severe. Fortunately, fixed rate mortgages dominate the market, so most people will have time to adjust in the mortgage market.

At the moment, any rise in either inflation or interest rates is purely theoretical, but it’s useful to consider what this would mean for you. It’s a good idea to draw up a budget for what you spend in a typical month, and have a good idea where you’d make cuts if you needed to. It’s also well worth any mortgage holder working out how their payments would be affected by a rate rise, and how they would afford it. That way, you can stop agonising about the impact of inflation, and go back to worrying about everything else again.

Living alone? You’re not alone

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More than 8 million people are living alone, driven by a boom in older men who have never been married. That’s 8.2 million people living without the demands of other people, who can do what they want, and focus on their own needs and priorities.

However, it’s also millions of people who are going through lockdown alone, many of whom have faced isolation and boredom. Single people have had to be particularly resourceful to cope without the automatic company of their household.

For some people, it has also been a useful reminder that taking a solo path to older age means we need to think especially carefully about building the right support for ourselves. This means ensuring we have enough pension savings for a comfortable retirement, building an emergency savings safety net of one to three years of expenses in retirement, and making a plan for how we’d pay for any potential care needs.

That way you can continue to have the single lifestyle you choose, well into older age.

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