Sean O'Grady: Falling inflation comes to rescue of savers

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If the Conservatives want to regain their reputation for economic competence, they will have to do better than this. David Cameron's claim that the "innocent victims" of "Gordon Brown's recession" include the nation's savers has some truth in it, but not enough to overcome the impression that the Tories are yet to grasp the magnitude of our economic problems. Long term, they may be right; but short term the last thing the economy needs is tax breaks to encourage more saving and less spending.

Yes, there is a squeeze on savers. Inflation was 4.1 per cent in November, the last figure available, and is probably closer to 3 per cent now – compare that with the 1.48 per cent available on instant access accounts and the 1.9 per cent on notice accounts. These figures, from Moneyfacts, are pre-tax, so the picture for most savers is even bleaker than it first appears.

But not for much longer. Inflation is plummeting. Prices – not just their rate of increase – will soon fall. The retail prices index will decline at an annual rate of close to 5 per cent, not seen since the early 1930s. The consumer price index, which doesn't take account of falling mortgage payments, will also turn negative, though less decisively. So even if you receive no interest on your savings, their purchasing power at the end of this summer will be greater than at the beginning. It won't feel that way, because monthly or annual interest cheques will be smaller, but savers will be winners from this recession.

Longer term, savers may lose a little; but recent times have hardly been a bonanza; the past five years have seen real returns on notice accounts average just 1.4 per cent a year. Real rates now may actually be higher than they were in September, when inflation peaked.

The Tory leader is thus suffering from what economists call "money illusion"; an inability to distinguish between the nominal and the real, inflation-adjusted, world. While this is a non-fatal illness, it often results in debilitating flakiness in stressful conditions, such as close proximity to fact.

The truth is that anyone wealthy enough to be living off the interest on a deposit account is likely to be a higher-rate ta payer, and thus ineligible for Mr Cameron's tax break. Basic rate taxpayers would hardly notice the difference. Meanwhile, Mr Cameron, more understandably, has nothing to offer on the more serious threat to savings – the one-third collapse in global share prices in a year, which has affected pensions catastrophically, and of course the sharp drop in house prices.

Much of the Tories' long-term thinking is sound. For example, Mr Cameron's national loan guarantee scheme will probably be what the Government ends up doing. But there is an immediate threat Mr Cameron seems unable to comprehend: that of a savage, uncontrollable deflation.Almost any risk is worth taking to avert that. As we saw in the 1930s, and in Japan more recently, once you're in such a slump no one can get you out of it – not even David Cameron.

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