Inflation is up but base rate won't move just yet

by Ed Bowsher on 19 January 2010  |  2 comments
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Inflation has jumped 1% which is bad news for savers. But the news isn't a huge surprise and I suspect the base rate won't rise in the very near future.

Inflation has jumped by 1%. The Consumer Price Index (CPI) - the government's favourite measure of rising prices - bounced from 1.9% in November to 2.9% in December. That's a chunky rise and no doubt some observers will see it as a harbinger of inflation taking off in 2010. 

However, I'm not so sure. Most people - including me - were expecting a rise around now. That's because inflation was exceptionally low in December 2008 due to: 

• VAT reduction from 17.5% to 15%
• Sharp falls in the price of oil
• Pre-christmas sales following the economic crisis

So when you compare prices in December 2009 with a year earlier, you're comparing with a low base. So it's not that surprising that price rises were relatively high last month. OK, I wasn't expecting the rise to be quite as high as 2.9%, but it's only a bit higher than I thought. I also expect inflation to be high for January 2010 thanks to VAT going back up to 17.5% and higher energy prices. 

But going forward, my prediction is that inflation will fall back later in the year. The economy is still pretty sluggish and may well slow down again once the next government starts increasing taxes and cutting public expenditure. Reduced demand in the economy will keep the lid on inflation. 

So if I sat on the Bank of England's Monetary Policy Committee (MPC), I'd see no need to raise the base rate in the next three months. My decision wouldn't just be down to the benign inflation outlook for the second half of the year. I'd also know that the Bank's money-printing programme - Quantitative Easing (QE) - will probably stop in February. Stopping QE will be a counter-inflationary move in itself, so that reduces the need to increase interest rates. 

What about savers? 

This is all bad news for savers. Higher inflation accompanied by a static base rate is just what savers don't need. It means that it becomes even harder for savers to keep up with inflation. If you're a basic rate taxpayer, you'll need to get at least 3.63% to keep up with inflation. 

Sadly, there's no easy access savings account that pays as much. The top easy access account - the Coventry 1st Class Postal - only pays 3.3%. (And you could argue that it's not really an instant access account as you're only allowed four penalty-free withdrawals each year.) 

You could beat 3.63% with some fixed rate bonds, but then you're tying your money up for several years and your current inflation-beating rate might not look so good in two or three years' time. 

Still, if I'm right and inflation does fall back in a few months, things won't be quite so bad for savers. But they weren't exactly be good either.....