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Saving grace

The latest inflation figures from the Office for National Statistics show the consumer price index has fallen to its lowest figure in two years and for the first time since February 2010, the governor of the Bank of England has been spared the job of having to write his monthly letter to the Chancellor to explain why inflation is more than 1 per cent above target.

April’s CPI inflation figures dropped sharply from 3.5 per cent in March to 3 per cent at the end of April but inflation remains a persistent problem and it is widely expected to remain above its target for some time.

Stubbornly high CPI, coupled with the BoE’s decision to continue to hold bank rate at 0.5 per cent in May, will not be welcome news to millions of households struggling to make ends meet.

The latest figures from Legal & General’s MoneyMood survey (see Figure 1) show that almost nine million households in the UK, 42 per cent, say they are only just surviving financially, meaning their household income just about covers paying bills and debts. Many of these households would like to be able to save more for the long term but may have to put money aside at the moment to pay household bills.

A further nine million households surveyed say they are managing to do some saving. These are the financially stable households that have some money left over at the end of the month after bills and debts have been paid.

However, this number is falling. Compared with September 2011, the period just before the UK fell back into recession, there are now about 800,000 fewer households in this stable savers group.

Although inflation is still well below its peak in September 2011, when CPI stood at 5.6 per cent, the squeeze on household finances continues to bite.

The really bad news is that there is no light at the end of the tunnel. In April, Paul Tucker, deputy governor of the Bank of England and one of the favourites to replace Mervyn King as BoE governor next year, predicted inflation might stay above 3 per cent this year and beyond, and this month, King also predicted inflation would stay above the official target of 2 per cent for “the next year or so”.

The bank’s previous forecast was for the inflation rate to fall to the 2 per cent target by the end of 2012.

Persistently high inflation should come as no surprise. Figure 2 shows that in our latest survey, conducted on April 20, only about 8 per cent of people we questioned about what they thought would happen to inflation in the next 12 months said it would be lower than now.

More than half thought it will be higher.

The crunch on household finances has come from the twin evils of low interest rates and falling wages. It is worth remembering that this comes at a time when wage growth remains well below inflation, as it has been for most of the last four years, according to the ONS.

The eight million households in our MoneyMood survey who are financially stable savers are also well aware that the gap between interest rates and the rate of inflation continues to present a risk to their capital of erosion from inflation and can result in falling returns.

For those who are hoping to supplement their income from their savings, if they are already in retirement perhaps, this can be a problem.
Many industry experts think it is eminently possible that the BoE could keep interest rates down at 0.5 per cent through to 2014 and possibly for as long as three more years.

The BoE Inflation Attitude Survey, published in December last year, revealed that people expect inflation to still be at 3.5 per cent in five years. If that happens, the purchasing power of household savings would be reduced to less than 85 per cent of today’s value.

As people continue to struggle against rising costs with little expectation of an increase in income from either their savings or earnings to help soften the blow, more households are already having to draw on savings to make ends meet. Almost a third of households questioned in the MoneyMood survey said they are likely to withdraw money from their savings over the next month.

Since the BoE started cutting bank rate, the typical savings rate has plummeted from 6.52 per cent in 2008 to 2.78 per cent today. Money-facts estimates that a basic- rate taxpayer would need to find a savings account paying 4.5 per cent a year to beat CPI inflation.

It is hardly surprising, therefore, that people in the UK are saving less than at any time in the past 40 years, according to figures from the ONS. In March 2008, the household saving ratio in the UK was 1.7 per cent of total resources, the lowest recorded since 1970 when it was 7.6 per cent on average for that period.

What is remarkable is that it is thought more than £100bn is sitting in accounts that pay virtually no interest, according to the BoE.
Official statistics from the ONS Wealth and Assets survey 2006-08 indicate that the average family in the UK has savings of £5,200, with a surprisingly high proportion in low-interest savings. Two-thirds of households have savings accounts and one-third has cash Isas.

In contrast, the number of homes with savings plans that have the potential to beat inflation over the long term is much lower. The ONS report says only 15 per cent of households own shares, 8 per cent have an investment bond and only 2 per cent have a trust settlor arrangement.

If, as the ONS data suggests, much of that money is just sitting there earning little or no interest, it would make sense to start making it work harder both to avoid erosion by high inflation and to generate a little extra income.

Assuming there are 20 million households in the UK, the ONS figure of £5,200 for the average amount held in savings accounts ties in well with the BoE estimate that there is more than £100bn sitting in zero-interest savings, which could potentially be put to work harder in shares, investment bonds and trusts.

Clients are often unaware they could have the potential to generate extra income from their savings.

With the prospect of stubbornly high inflation and the likelihood of continued low interest rates for some time to come, you should revisit your clients to explore ways of building, managing and maximising their income both before and during retirement.

As we are at the beginning of another tax year, why not suggest your clients undertake a review of their tax position to ensure all allowances, exemptions and any tax relief are used to help secure the maximum income for the tax year ahead?

Planning ahead for income by making savings work that little bit harder could be crucial if investors want to mitigate the impact of inflation over the coming years.

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