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[MSE Martin]

Shock news for SAVERS.
If inflation's at 0.1% you’ve never had it so GOOD!

Inflation's nosediving as the economy plummets, so savers must fundamentally change their thinking, to deal with the new savings reality. I hope my shocking, but not wholly inaccurate headline’s grabbed your attention, so please read & think about this...

Interest can't be considered in isolation, its interaction with inflation's crucial. In these three scenarios, I’ve done the maths over a year to make it easier to understand, though really things change monthly. Also I've used RPI inflation which for many isn't accurate - see below.

• July 08. Top Savings 6.5% . Inflation (RPI) 5.0%. Save £1,000 for a year and after basic tax you get 5.2% interest ie you’d have £1,052. Yet a basket of goods that cost £1,000 would now cost £1,050 due to inflation. Thus saving only increased your spending power by £2. REAL interest: 0.2%.

• Current: Top Savings 3.5%. Inflation (RPI) 0.1%. Save £1,000 for a year and after basic tax you get 2.8% interest ie you’d have £1,028. A basket of goods that cost £1,000 would’ve only increased to £1,001 due to inflation. Thus saving increases your spending power by £27. REAL interest: 2.7%.

• Possible future: Top Savings 1.5% Inflation (RPI) -2.0%. Save £1,000 for a year, and after basic rate tax you get 1.2% interest, ie £1,012. Yet a basket of goods that cost £1,000 would have DECREASED to £980 due to deflation. Thus saving’s increased your spending power by £32, meaning your REAL interest: 3.2%.

Is inflation really that low?

While RPI is 0.1%, the CPI rate which excludes mortgages is currently 3%. This variance has a huge impact on the numbers above, so do check your personal inflation rate. For some, who have very high rates, sadly you'll realise your money's doing even more badly that it seems right now. Yet hopefully at least this has explained the concept.

What about those living off savings income?

This is where it really has to hit home. Many have entrenched, psychological “don’t spend your capital" rules. Yet we may need to change that in coming climes. If we do get a true low interest deflationary environment, you CAN spend some capital to live off, without diminishing purchasing power – and in fact if you need to, you should.

My great worry is people will unnecessarily take hugely decreased lifestyles or even risk heat and food to protect their capital.

Max your interest Top Savings, Top cash ISAs



PS. I posted an earlier draft version of this and asked regular Forum users for feedback, as it's a thought piece. There were many useful and thought provoking comments (and a few rude ones as always). I've incorporated tweaked, and tidied the note above. Thanks to all for your help.

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[nzseries1]

I'm still confused as to the difference between CPI (3%) and RPI (0.1%).
Thanks very much for the figures though, Martin, they are reassuring.

[grn.w.nv]

Thanks Martin - very interesting reading and certainly food for thought

[anselld]

RPI is a reasonable measure for those with mortgages, however many savers have not benefited from falling mortgage rates, either because they are on a fixed rate or they don't have one. For them a better inflation measure is CPI or RPIX, both in 3% territory. This tips the balance significantly.

It all depends, as you say, on your circumstances.

[MSE Martin]

Originally Posted by anselld

RPI is a reasonable measure for those with mortgages, however many savers have not benefited from falling mortgage rates. For them a better inflation measure is CPI or RPIX, both in 3% territory. This tips the balance significantly.

It all depends, as you say, on your circumstances.

Good point. I tried to avoid debates on inflation rates - hence linking to the personal inflation calculator. For me the key is to educate people that you can't look at savings rates in isolation from inflation rates.

[Wookey]

I personally feel that retail prices are still to high, after the fuel escalation we seen during the first 8 months of last year just about every retailer jumped onto the price rise bandwagon, now that fuel has returned to roughly where it was those same retailers still haven't returned there prices to similar levels. Untill the prices return it certainly wont feel like we have more spending power.

[anselld]

Originally Posted by MSE Martin

For me the key is to educate people that you can't look at savings rates in isolation from inflation rates.

That is certainly very true and not well covered in the press to date.

[Lokolo]

As a student I only buy basic things such as food, pay for bills etc. which means my actual inflation is around 5%.... I am losing out

[themanbearpig]

Except inflation isn't really 0.1% is it?
Its 3.0%, as we have been using CPI for years.

Good post though, as it is imporatant to relate interest rates to inflation.

[KingL]

It's interesting to see the breakdown of what elements contribute what proportions : http://www.statistics.gov.uk/PIC/dow...SubIndices.pdf

[Decadent Fool]

I hope this starts to draw a line under the savers problems, and we can work towards solutions to their problems instead of just bemoaning the current situation

[Reaper]

lol - brace yourself for the backlash of pensioners saying they "live off the interest" and now they are worse off. I've tried and failed to explain this before.

However with regards to pensioners they are less likely to have mortgages so they will be nearer the 3% CPI figure.

[tsmlion]

It's a fair point to make but dangerous to advise people to spend capital.

Practically zero rates transfer the onus of achieving returns from the banks to the private individual. People are being asked to take risks with their own money. This, it is hoped, will stimulate asset buying. Certain assets are still good for above average returns so I think a run down of options available would be better than simply saying spend existing capital. After all, what happens when that runs out?

[Reaper]

tsmlion - that's not quite it. If inflation and interest rates were both 5% and you live off the interest then you are already reducing your capital by 5% every year without realising it.

If interest rates and inflation are both 0% then you can dig into 5% of your capital and be no worse off.

You are not being asked to take risks with your money.

[mike22]

I have £5000, shall I put in Fixed Bond with AER 3.75 % or not?

[freddysmith]

Originally Posted by mike22

I have £5000, shall I put in Fixed Bond with AER 3.75 % or not?

If I didn't need the cash for anything else and any outstanding depts paid for then I would have no problem locking up the money for a year at that rate.

[Milarky]

purlease!. As themanbearpig says, inflation reported at 3% is just a distortion of the cuts to mortgage customers. For once, CPI is much nearer to true inflation (and still above the BOE's own target, notice) than RPI. RPI has been ripped to pieces as a representative measure of the 'cost of living'. That is the debate we should be having today.

As to 'educating people', just stick with 'money illusion' (the effect of ignoring the presence of 'inflation' when looking at nominal interest rates and asset prices for assets bought some time ago...) But, turning that around, and claiming that a statistical blip has made people better off?? Really!!!

[gozomark]

Its funny that when RPI was higher than CPI, these boards were full of people saying RPI was the better measure of inflation as it included housing. Now its lower, its CPI is better.......

As it happens, CPI is a better measure of underlying inflation - not just the housing aspect, but its also statistically a better indicator in terms of composition - RPI actually tends to overstate inflation over the long term due to its weaker basket rebalancing techniques. However, most people have mortgages, so RPI has its uses

completely agree with the money illusion point - I and many others have made it time and time again on the boards, but still people insist on the "I'm not spending my capital" line - fine, but then understand that its real not nominal capital that you should be protecting

[derrick]

In the third of Martin's scenario, should "Inflation" not read "deflation"?

Originally Posted by MSE Martin

• 
  

• Possible future: Top Savings 1.5% Inflation (RPI) -2.0%. Save £1,000 for a year, and after basic rate tax you get 1.2% interest, ie £1,012. Yet a basket of goods that cost £1,000 would have DECREASED to £980 due to deflation. Thus saving’s increased your spending power by £32, meaning your REAL interest is 3.2%.

.

[KingL]

Interesting to note that if you use CPI data in Martin's scenarios, the real interest rates turn out as
Jul 08: +2.4%
Current: -0.2%
Poss future: -2.3% (assumes CPI at +1.1%)

If one accepts that the people who need most assurance are pensioners who personal inflation is nearer CPI, then that's still a cause for worry.

I tried to avoid debates on inflation rates

Unfortunately, that's just what you will get!!

If you are after a postive spin, then maybe there's a need for a calculator app, where people can key in their own circumstances (incl personal inflation) with the slant that 'even if your spending power is eroding, just look how slowly it is happening, and how long it would take before it became a problem..."