Inflation is running at rates we haven't seen for 20 years – it reached 5.2% in
September 2011. At that rate the value of the money you have spent a lifetime
saving up halves about every 13 years. If you have £10,000 in the bank today by
the middle of 2025 it will only buy as much as £5000 would get you now.
Inflation destroys savings.
Officially Government policy is that inflation should be 2%. But if it really
meant that it would have sacked the Bank of England's Monetary Policy Committee
which for 25 months has failed in its single job of keeping it down to that
level. Instead it gave MPC chairman, Governor Mervyn King, a knighthood.
High
inflation has the big disadvantage for the Government that the pensions and
benefits it pays out, and the tax allowances which let us keep more of our own
money, both rise with inflation. So the Coalition decided to change the measure
of inflation it used to the Consumer Prices Index.. This CPI is systematically
lower than the old Retail Prices Index (RPI) which we have used to measure
prices since World War II. Ignore the BBC's monthly mantra that CPI is lower
because it ‘omits housing costs’. It does, but that isn't why it's lower. In the
long run CPI will be 1.4 percentage points lower than the RPI and 1.0 of that is
due to the different maths it uses. Which is bad news for people on pensions who
tend to experience inflation which is higher than the RPI because the price of
essentials like food, fuel for heating, and transport all tend to rise more
quickly than things that are not essential.
The Bank
is letting inflation rip because it daren't use the one lever it has to control
it – interest rates. Normally with inflation above target for 25 months the Bank
of England would raise interest rates to dampen demand and cut prices. But the
economy is so fragile it dare not do that in case it tips us back into
recession. So it does the opposite – printing money to boost demand to try to
keep the economy in a state of growth. Printing money always has one effect from
the Weimar Republic to Zimbabwe – it puts up inflation. The Bank's own research
indicates that printing the first £200 billion could have raised inflation by as
much as 2.5 percentage points. In other words if it hadn't started up the
electronic banknote presses in March 2009 inflation could now have been almost
on target. But the Bank has recently embarked on a second round with another £75
billion created electronically out of nothing, and more to follow. Time to order
the wheelbarrows.
And just
as prices are rising and incomes from pensions and benefits are restricted, our
money in the bank is generally earning pathetic returns because the official
interest rate is languishing at half of one percent. The banks have joined in
this low interest rate party with a vengeance (on us). Some savings accounts are
paying as little as 0.1%. So £100,000 would bring an income of £1.52 a week
after tax. The average return is higher, around 1%. But even an income of £15 a
week from £100,000 of savings is pretty poor.
However,
in 2011 there was a glimmer of hope of better returns. We have not trusted the
banks for some time. But last summer they stopped trusting each other.
The
hundreds of billions of pounds of our money the banks hold is not given any
rest. They lend it to each other. The rate they charge is called BBA LIBOR
(British Banker’s Association London InterBank Offered Rate) and the rate for
money to be repaid in three months (three month Sterling LIBOR) is normally a
fraction over the Bank Rate. It started 2011 at 0.75%, drifted higher and then
in August began to rise sharply and ended the year at 1.08%. That increase of
almost half shows a growing lack of trust among the banks that they will get
their money back. That is why the ultra-safe Swiss National Bank has been able
to charge negative interest rates for three-month loans on a couple of occasions
recently – in other words it has been charging banks to deposit their money in
its Alpine vaults. It is return OF your capital rather than return ON your
capital which is important now.
So if
not from each other where do our banks find the money for mortgages and loans?
They have to go to the half of the population that has money rather than debt
and tempt us with half decent rates of return. As a result you can earn more
than 3% even on instant access savings if you look around. And if you want to
tie it up for a while you can earn more than 4%. These rates are now around 0.5%
higher than they were a year ago. And as banks trust each other less and rely on
us more, 2012 could see these rates rise.
The
price of these half-decent returns is eternal vigilance. Show the banks as much
loyalty as they show us – none. Move your savings every six months if need be.
And never keep more than £85,000 in any one bank. Then at least your capital is
protected if the worst happens.