UK inflation slows, but don’t get too comfortable: it’s set to hit the accelerator again

Sarah Coles, personal finance analyst at Hargreaves Lansdown, comments on the publication of ONS statistics of inflation data for July, showing that the UK inflation has slowed, but set to accelerate again.

Key points from data:

• The Consumer Price Index measure of inflation fell to 2% in July (down from 2.5% in June).
• However, the Bank of England expects it to rise again and hit 4% by the end of the year.
• Inflation was held back by an artificial bump in prices a year ago when the ONS stopped using estimates and stared measuring prices again. When this drops out of the figures, inflation will rise.
• Even at 2%, inflation is running ahead of savings rates. You can currently make a maximum of 1.7% in a standard savings account, and that involves tying your money up for five years.

Sarah Coles says:

“Inflation stepped off the accelerator in July, but this doesn’t mean we’re set for a gentle ride, because it owes an enormous amount to an artificial bump in prices a year earlier. The underlying pressure on prices, particularly from soaring petrol and second-hand car prices, mean it’s set to pick up speed again soon, and may well hit 4% by the end of the year.”

Why inflation has fallen:

“We were always going to see some downwards pressure this month, because this time last year, when the economy reopened, the ONS started being able to measure prices for the things it had been estimating for months – like flights and hotel stays. As a result, we saw an artificial bump in prices.

“We’re seeing this bump feed into the 2020 figures, which automatically depresses inflation over the past 12 months. This isn’t going to be a lasting effect, because from this point onwards we’ll be comparing two sets of data where prices were collected more normally.

“A shift in seasonal fashion sales has also fed into the figures. This year, the summer sales came slightly later than usual, because lockdown depressed prices in the first two months of the year and retailers have been making up for lost time ever since. However, discounts started in earnest in July. Last year, retailers discounted throughout the first lockdown to shift stock from shuttered shops, which meant fewer discounts in the summer.

“Computer games also pushed prices down. This is always something of a lottery, because it depends on the price points of the most popular games, and in July these happened to be cheaper.

“These price cuts have offset some of the surging price of petrol, which hit 132.6 pence per litre – its highest price in eight years – and the rising price of second-hand cars. Demand for these cars has boomed as people looked for alternative forms of transport and have been thwarted in their attempts to buy new. New car production has fallen significantly because of the global chip shortage, and faced with waiting lists of up to a year, buyers are turning to older models. Meanwhile, fewer new cars sold during the first lockdown, and widespread extension of leases, means the supply of nearly-new cars has fallen too. A combination of all these factors meant second-hand cars made more of a contribution to inflation than at any time in the past 11 years.”

What happens next?:

“Next month, when the artificial bump in 2020 falls out of the figures, we’re going to feel the pain from these price rises more keenly, so inflation will rise again. The Bank of England expects it to hit 4% towards the end of 2021.

“At that point, it expects it to drop back, as the impact of the first lockdown drops out of the figures, and supply bottlenecks unwind, so there’s not as much pressure on prices.

“However, inflation prediction is not an exact science, and there are some signs of more enduring inflationary pressures. The cost of raw materials is rising for manufacturers, and while many of them are keeping a lid on the price of the finished products, if they come under too much pressure, they’ll pass them onto consumers. They also face the threat of possible wage rises as vacancies hit record highs. If we get prices and wages both rising together, we could find ourselves in an inflationary spiral that’s very hard to get out of.

“On the flip side, you can never discount recovery being derailed by the virus again. How the spread of the Delta variant changes when we move inside during the autumn and winter is an unknown quantity, while new variants could cause a whole new set of problems. If this happens, inflation could be a distant memory in a matter of weeks.”

Savers:

“Even at 2%, inflation can do serious damage to your savings, so we need to protect ourselves by refusing to settle for miserable rates from the high street giants. These usually offer 0.01% on easy access, while the average is 0.07%, and the most competitive without restrictions is 0.65%.

“For any cash beyond our emergency savings of 3-6 months’ worth of essential expenses it’s worth considering tying it up for a better rate. Fixing your savings for 12 months, for example, will earn you up to 1.3%, which will significantly reduce the damage inflation does to your savings.

“We should also revisit how much we have in cash beyond our emergency savings. For any sums you don’t need for 5-10 years or more, there’s the potential to invest some of it. This involves risk, and the value of your investments will rise and fall in the short term, but it at least has the potential to grow faster than inflation.”

Kindly shared by Hargreaves Lansdown

Main photo courtesy of Pixabay