What problems can rising inflation cause, and what steps can you take to mitigate the effects?

According to the latest Office for National Statistics data, UK inflation has recently reached a 30-year high of 6.2%. And, the problems could be about to worsen, with experts predicting it could rise to over 7%, a level US inflation has already reached.

Rising inflation can affect your finances in a range of different ways. So, as the so-called “cost of living crisis” takes hold, read on to find out more about what high inflation means for you, and how you might deal with its impact.

Inflation can decrease your purchasing power

Inflation measures the rate at which prices are rising. So, the higher the rate is, the faster the cost of living is increasing.

While inflation is a common phenomenon, a higher rate of inflation means your purchasing power is eroded faster. For example, at the current rate of 6.2%, something that cost £100 a year ago would now cost you £106.20.

While this doesn’t seem like much at first glance, this rise in the cost of living can have serious negative effects in the long term. According to Thesis, even if the rate of inflation stayed consistently at the Bank of England’s 2% target, your money would be worth a third less in 20 years than it is today.

There are a couple of key ways that inflation can affect you.

1. Your savings could lose value in real terms

Since the global financial crisis, interest rates have been at record lows. This has meant that savers have been forced to contend with low rates – often much lower than the rate of inflation. When your interest rate is lower than the rate of inflation, your savings will lose value in real terms.

To give you an idea of how this might affect you, Moneyfacts reports that, as of March 2022, the best easy access savings account offers an interest rate of just 0.77%. This means that for every £100 you save, you would have £100.77 a year later.

Compare this to the current rate of inflation – if something you purchased a year ago for £100 costs £105.50 today, it shows your savings aren’t keeping up with the rate of inflation and the value of your money is falling in real terms.

2. Your mortgage payments may increase

When inflation rises, one of the actions the Bank of England can take is to increase the base rate to try to bring inflation closer to their target of 2%. The theory is that, by increasing interest rates, the cost of borrowing money rises, and consumers and businesses have less money to spend. So, demand tends to fall, economic growth slows, and the prices of goods and services should fall.

However, while raising interest rates may help alleviate the issues inflation causes, it could also increase your mortgage repayments.

If you have a tracker-rate mortgage, then you can expect your repayments to rise in line with any base rate increase. Variable-rate mortgages will also tend to rise as the base rate rises, although this is at the discretion of your lender.

How you can tackle rising inflation

You will be glad to hear that there are several things you can do to protect your money from the negative effects of inflation and the rising costs of living.

Find a savings account with higher rates of interest

As previously mentioned, there are few, if any, savings accounts that provide rates of interest that can keep up with current inflation rates. Although this may be the case, it is still worth searching for a savings account that can at least soften the blow inflation has on your savings in real terms.

Fixed-rate savings accounts, for example, tend to have higher rates of interest than other types of savings account. According to Moneyfacts, the best five-year fixed-rate savings account as of March 2022 would offer an interest rate of 2.22%.

The trade-off for higher rates on a fixed-rate account is that you are required to lock away your money for a longer period of time unless you wish to face penalty fees.

While this is still lower than the current rate of inflation, it could help limit the effects it will have on your savings.

Review your budget

A good way to tackle the rising cost of living is to interrogate your own expenditure.

Taking the time to review your monthly expenses could help you to spot costs that you have completely forgotten about.

For example, you may be paying for a monthly magazine subscription that you no longer read, or for a gym membership you don’t use.

If you review your budget and cancel the direct debits you don’t get value from anymore, you could end up saving money and have more cash to spend in the face of rising costs of living.

Consider investing your money

Another way to help your savings retain their real value could be by considering investing.

In the long term, investing tends to provide positive returns that outpace inflation. Indeed, the investment platform IG reports that, between 1984 and 2019, the FTSE 100 gave an annual total return of 7.8% with dividends reinvested, not accounting for fees and charges.

It is worth keeping in mind, however, that past performance is not a reliable indicator of future returns, so if you need help building a portfolio of investments you should get in touch with a financial planner.

Get in touch

If you would like some help dealing with the rising costs of living or advice on how to make your money work harder amid high inflation rates, email us at enquiries@alexanderpeter.com or give us a call on +44 1689 493455.

Please Note

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it. Think carefully before securing other debts against your home.

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