Inflation On The Rise Again

27.04.10

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Inflation has been thrust back in the spotlight with higher than expected increases for the UK and the Eurozone in March.

This is yet another blow for savers. Their cash deposits hav

Inflation has been thrust back in the spotlight with higher than expected increases for the UK and the Eurozone in March.

This is yet another blow for savers. Their cash deposits have been earning meagre returns for some time and the increased cost of living means they will now receive less interest in real terms ? i.e. after tax and inflation – than they did a month ago. You may be earning negative rate of returns, depending on what your personal inflation rate is and how much interest your bank is paying.

UK

There was an unexpectedly large rise in inflation for March. The Consumer Price Index (CPI), which is the government?s preferred measure of the cost of living, showed prices rose on average by 3.4% in the year to March, an increase from 3% in February. Economists had predicted it would be 3.1%.

It was the 17th time in the last 24 months that inflation was higher than economists had forecast? which leads one to wonder if inflation will continue to confound expectations.

The Bank of England?s target is 2%, and economists now warn that inflation will probably remain above 2% for a few months.

The Retail Price Index (RPI), which includes housing costs, also jumped from 3.7% to 4.4%. Even core inflation, which strips out volatile food and energy costs, increased slightly, from 2.9% in February to 3% in March.

If the CPI stays above 2% in April the BoE governor, Mervyn King, will have to write his seventh letter to the Chancellor explaining why the target was missed for another quarter.

Eurozone

Inflation also rose sharply in the Eurozone, although it is lower than in the UK and still under the European Central Bank target of 2%. Inflation had been 0.9% in February, but in March hit 1.4% – a significant rise. Analysts had expected a smaller increase to 1.2%. The highest increases were in transport (6.1%) and alcohol & tobacco (4%).

Inflation is now at its highest level since December 2008. It has risen continuously since last November as a result of the economy moving out of recession.

Inflation rates vary across the Eurozone countries, with Hungary suffering the largest inflation at 5.7%, followed by Romania at 4.2% and Greece at 3.9%. Some countries are still in deflation territory, with inflation at -4% in Latvia and -2.3% in Ireland. For the 27-nation EU as a whole, inflation rose from 1.5% to 1.9%.

Causes

In the UK, the Office of National Statistics blamed the spiralling cost of petrol for much of the increase, after oil prices hit an 18-month high. Transport costs were up 11.3% on the year ? the largest increase since comparable records began in 1997.

Other factors were the increase in VAT to 17.5% from 15%, which automatically makes many prices higher than a year ago, and also the weakness of Sterling which makes imports more expensive.

Food prices also helped push inflation up, particularly the price of vegetables after the cold weather earlier in the year.

In the Eurozone, the rise is also blamed mainly on higher energy prices, and food prices affected by the weather contributed. As the Euro weakens, Eurozone residents may start to see imported goods become more expensive.

Fighting inflation

As the demand for oil picks up as economies around the world recover from the downturn, the price of oil is unlikely to decrease ? and it may continue to go up. As regions like Asia continue growing, this will drive up the cost of key commodities.

At the same time, monetary policy remains loose and, as the Bank of England has said, the effects of quantitative easing are still filtering into the economy.

Central banks normally raise interest rates when inflation increases, but while the economy is improving we still have some time to go before we return to ?normal?. The Bank of England and European Central Bank are unlikely to be in hurry to increase interest rates and when they do move to tame inflation they may first opt to reverse quantitative easing measures.

Tax increases and spending cuts could also potentially be used to curb the rise in the cost of living.

Savers

It is now even harder for savers to fight against tax and inflation. In the UK, according to MoneyFacts only four cash accounts are now paying a real return to higher-rate taxpayers.

As an example of the effects of inflation, a report in The Times calculated that basic-rate British taxpayers now need to receive 4.25% interest just to avoid earning negative real returns, while for higher-rate taxpayers the interest would need to be 5.64%. Last year competition between banks for savers? cash pushed fixed rates up, but unfortunately this is no longer the case.

Millions of savers are now earning lower real rates of return. Retirees are particularly hit as they often rely on their savings income to augment their income, and they also need the value of their capital to keep up with inflation.

If you are retired or saving for retirement, your capital needs to keep up with the pace of inflation, both now and throughout your retirement, to prevent your spending power reducing year after year. Official inflation forecasts only tend to look at the short to medium term, whereas your concern is long-term inflation. An experienced wealth manager like Blevins Franks will be able to advise you on financial planning to protect your wealth from both inflation and taxation.

By Bill Blevins, Managing Director, Blevins Franks

22nd April 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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