At a glance
A higher than average inflation rate means that, over time, the purchasing power of your savings may be reduced.
Building a diversified investment portfolio can help protect your money against inflation.
Over time, equity investments such as stocks and shares tend to provide greater returns than the average rate of inflation, although this may not always be the case.
Although, at time of writing, the UK inflation rate has been steadily dropping1,understanding the balance between inflation and interest rates remains a hot topic for savers and investors.
How does a high inflation rate impact my spending power?
Interest rates and inflation rates can fluctuate dramatically, as we have seen in the past two years. And that can have a very real effect on the spending power of your savings and investments, as well as your day-to-day household expenditure.
Rising inflation means most things cost more. And the knock-on effect of that is that any savings you have won’t buy as much in the future, unless the interest that you are earning on them outstrips the rate of inflation.
For much of 2023, we saw inflation rates that were higher than interest rates. Which means that cash savings or cash ISAs simply couldn’t achieve the necessary growth to match the rising cost of living. By June 2023, food prices were up by 17.3%2.
Even though inflation is now in single digits at 3.4%, it’s still over the average 2% target set by the government.
According to the Bank of England, it remains difficult to predict how interest rates will respond.3 The latest Monetary Policy report says that it won’t cut interest rates until inflation is steady at 2%, so the inflation rate will need to fall, and then stabilise before it considers changes.
So it’s a wise idea to keep checking your current interest rates on any Cash ISAs or savings accounts, to see how they measure up against inflation, whenever new monthly figures are released.
While it’s always encouraging to see a higher than average interest rate, without wanting to rain on the parade, savers have to be careful to make sure their savings income doesn’t exceed their personal savings allowance: £1,000 for basic rate taxpayers and £500 for higher rate tax payers or the starting rate for savings, should they qualify for it. There’s no personal savings allowance for additional rate taxpayers. So, you might earn more interest, but need to hand some of it back to HMRC.
If inflation rates rise again, will a bank account protect my savings?
When it comes to beating inflation, relying solely on your high street bank savings isn’t always the best strategy.
While banks do pay interest on instant access savings and Cash ISAs, the typical high street rates don’t always outpace, or even keep pace with, inflation. As we’ve seen, this means that the purchasing power of your savings slowly declines.
If there’s a gap between the Consumer Price Index or inflation rate, and the base rate of interest, it’s quite hard to find savings providers that will offer returns above the rate of inflation.
How long-term investing can help you beat inflation
If you’re planning on saving over the long term, then investing could be a better way to shield your money from inflation.
The key to beating inflation is by investing in assets which produce a higher rate of return than interest rates. Over the long term, that tends to be equities – stocks and shares. They have the ability to outpace inflation, although that doesn’t always guarantee that they will.
You should be aware, however, that investing does come with a certain degree of risk. An adviser will always discuss what level of risk you feel comfortable with, and help you choose a diverse portfolio that’s appropriate for you, and your long-term financial goals.
Don’t put all your eggs in one basket
Spreading your investments across different types of assets – such as equities, bonds or property – is also a good way to diversify and strengthen your portfolio.
Different assets may perform differently under different economic conditions. No single type of asset will be the best performing one forever – so by keeping a diversified portfolio, you can help make your investments more resilient. Whatever inflation and interest rates are doing.
Please be aware past performance is not indicative of future performance.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.
Equities do not provide the security of capital which is characteristic of a deposit with a bank, building society or Cash ISA.
Sources
1Office for National Statistics - 17 January 2024
2Food Foundation Food Prices tracker - 18 July 2023
3Bank of England - 22 March 2024
