Should you worry about inflation?

We ask the experts how you can protect your money.

The Governor of the Bank of England isn't the only one keeping a close eye on the rate of inflation. (Getty)

If you were alive during the 1970s you’d be forgiven for being slightly bemused by this week’s fuss about an inflation rate of, oooh, very nearly 2 per cent.

It’s as nothing compared with the now incredible 25 per cent seen during the dark days of 1975. But in today’s world that’s the highest rate of inflation we’ve seen in more than two and a half years as, for the most part, the knock-on effects of a weak pound make imported goods more expensive for the consuming public.

“There is a good dose of irony in sterling’s reaction to Britain’s remorselessly rising inflation,” says David Lamb, head of dealing at FEXCO Corporate Payments. “With the Pound’s weakness unmasked as the villain of the piece, sterling duly responded today by plunging further.

“The trouble is inflation is rising at an anti-Goldilocks rate – neither bad enough nor mild enough. It's not fast enough for the Bank of England to hike interest rates, nor slow enough to stop economists fretting about its growth-sapping erosion of consumers’ buying power.”

But with wages rising faster (albeit only slightly) than the cost of living, is there really a problem?

Potentially, warn experts, after the latest labour market figures from the Office for National Statistics this week showed an unexpected dip in wage growth to 2.6 per cent a year.

Mind the gap

“This means real wage growth continues for now, but with inflation forecast to hit 2.8 per cent early next year, a deceleration in pay growth could see real wages fall at some stage,” says Ben Brettell, senior economist for Hargreaves Lansdown. “This would squeeze household budgets as we move through the year.

But he adds: “Economists and financial institutions have repeatedly forecast the UK's unemployment rate will rise as a result of the vote to leave the EU. Yet the UK labour market continues to confound the doom-mongers with its resilience to the Brexit shock.

Others disagree, warning that the narrowing gap between spending power and inflation could spook consumers into calling time on spending that has so far kept the UK economy powering through post-referendum uncertainty.

Elsewhere though, the impact is already being felt. So short of spending it all now, what options are there for those trying to preserve their precious pounds?

Nowhere to go

A year ago savers had 118 fixed deals on the market to choose from that paid a respectable 2 per cent or more, but this has eroded to just 11 accounts – all of which require savers to tie their cash in for five years or more.

Today, despite a smattering of interest rate rises and new deals outweighing cuts, only 23 of 697 savings accounts currently on the market can beat or match inflation, and all of them are fixed rate bonds.

“Most of the new deals that have surfaced this year pay rates that are below the current level of inflation, but they can still earn a position among the best accounts,” says Rachel Springall, finance specialist at Moneyfacts.co.uk.

“Unfortunately, the lack of rivalry among savings providers has meant brands such as NS&I have slowly crept up towards the top of the market, which has led to the inevitable decision to cut rates that will hit millions of savers.

“Savers are clearly running out of options for an inflation-beating return, unless they lock their cash away for the long term or are prepared to place their funds in more riskier investments.

“Until competition heats up, savers must make do with the NS&I bond in the spring, expected to pay 2.20 per cent for three years, and the rise of the ISA tax-free allowance to £20,000 from April."

Skinny yields

But bumping up the risk and return spectrum shouldn’t simply about putting your money into anything that isn’t cash.

“The problem for investors is that inflation can eat into their investment returns and thereby erode the real value of their assets,” says Ryan Hughes, head of fund selection at AJ Bell.

So what should investors consider?

“Equities’ relationship with inflation is all a matter of degree – a little inflation can be good but lots of inflation is bad, at least if history is any guide.

“If inflation does take hold but does not zoom off to the double-digit levels of the 1970s then it would seem reasonable to expect stocks to outperform bonds, especially as the skinny yields currently offered by vanilla sovereign bonds in particular would be swiftly eroded in real terms by the surge in prices.

“Index-linked or floating-rate bonds would, however, be a potential bolt-hole and there are some funds which specialise in these areas [such as the M&G Index-Linked Bond or Global Floating Rate High Yield]”

“On the stock front, companies that are able to consistently grow their dividend payments can also provide a natural buffer against rising inflation. A high quality equity income fund such as Artemis Income is a good choice here.”

“In the long-term, the best response to inflation is to target companies which have pricing power,” he adds.