In recent weeks you might have seen the news that inflation in the UK is rising. Indeed, the Bank of England has projected that inflation could rise to as high as 4% this winter.
Simply put, inflation is the rate at which prices rise. According to the Office for National Statistics, the most recent measure of inflation was 2.5% in June 2021. This means that compared to June 2020, prices are an average of 2.5% higher. Something that cost £100 in June 2020 would have cost £102.50 in June 2021.
If inflation were to reach 4%, it would be at its highest point in a decade, as the last time it breached the 4% mark was in November 2011. Although the Bank of England has predicted it to be just a temporary spike in price rises, does it provide cause for concern?
A problem for savers is that the interest rates currently available on savings accounts pay significantly less than the inflation rate. With interest rates at record lows, often below 1%, prices are rising much faster than the interest on your savings.
The inflation rate is an important consideration for savers
Low interest rates and high inflation is not a good combination for savers, especially if you have your money in a traditional savings account.
Imagine you have £1,000 in a savings account and you leave it untouched for a year. At 2.5% inflation, you would need £1,025 to buy the same amount of goods a year later.
As of 10 August 2021, Moneyfacts say that the best easy-access savings account pays just 0.6% interest. If you saved £1,000 you would have just £1,006 at the end of the year.
Simply put, you can buy less with your money in a year than you can today, so its value has fallen in real terms. While you may be getting interest added in every year, prices are currently rising faster and so you’re losing out.
Laura Suter, head of personal finance at AJ Bell, comments: “With the top easy-access cash account paying 0.6%, savers need to question whether they need all the money in cash.”
If inflation were to rise to 4% and interest rates remain at the same level, then the disparity between prices and savings will only increase. Using the £1,000 example again, but with 4% inflation and 0.6% interest, prices could rise to £1,040 while your savings rise to just £1,006.
You could be losing a significant amount of spending power by keeping your savings in cash.
Investing your cash offers the possibility of higher returns
Investing your cash can be one strategy to try and maintain the real value of your savings. Though cash savings are considered safer, investing has the chance to provide you with higher returns; a chance that only grows with the amount of time spent in the market.
Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, says: “Equity income funds offer average income of about 3.5%, not far off a 4% inflation rate but, importantly, provide the opportunity to grow as well as offering capital gain over the longer term.”
Nutmeg have found that the chances of making an investment return increase over time. Using market data from January 1971 to May 2020, they found that investing for 10 years in the market at any point during this time frame yielded an almost 94% chance of generating positive returns.
But while investing may generate higher returns than savings, especially given the low interest and high inflation rates, this is not a guarantee, and it should be considered a long-term project.
If you’re interested in getting started with investing, take a look at our list of the best trading platforms in the UK.
The value of your investment 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.