Savers to suffer as inflation soars to 3.5%

Higher VAT and petrol prices pushed prices up at the fastest rate for 14 months in January.

Last Updated: 31 Aug 2010

As expected, today’s news on inflation wasn’t pretty: the Consumer Price Index measure jumped from 2.9% to 3.5% in January, the biggest jump for over a year, while the Retail Prices Index was up from 2.4% to 3.7%. No prizes for guessing why: the return of VAT to 17.5% was the most significant factor (so you wonder what a further hike would do), although everything from petrol to vegetables also rose in price. Bank of England Governor Mervyn King has had to write his sixth (largely pointless) letter of explanation to the Chancellor, but he’s unlikely to do anything else. Not great news for prudent savers…

This latest jump means inflation is now more than 1% above the Bank’s 2% target – hence the daft rigmarole of the Governor’s letter to Alistair Darling. As you’d expect, he cited the rise in VAT (i.e. the Chancellor’s own policy) as the primary cause, followed by the 70% increase in oil prices over the last year. He also suggested that we’re still feeling the effects of the big fall in sterling in 2007 and 2008, which has made life a lot more expensive for retailers to buy in supplies. Some vegetables were also more expensive because of the cold weather, as you’ll no doubt have noticed if you’ve bought any carrots or cauliflowers lately (and, unlike us, you have some idea what a cauliflower usually costs).

However, Merv doesn’t seem unduly worried: he’d predicted this last month, and he suggested today that although inflation would probably remain high ‘over the next few months’, it is ‘more likely than not to fall back to the target in the second half of this year’. Of course, any upward revision to the VAT rate would push prices up again – and new research from LexisNexis, out today, suggests that a hike to 20% is ‘a near certainty’ (judging by past history and sales tax rates elsewhere in Europe). But if that doesn’t happen, King’s letter seems to suggest that he’s not planning to fiddle with interest rates any time soon.

Some economists (like ex-MPC renegade David Blanchflower) reckon a period of higher inflation wouldn’t be a bad thing; it’d reduce the size of the national debt, and stop house prices sliding to such an extent that people will be forced into negative equity. But unfortunately there are drawbacks too. Employers who have to base wage deals on the current level of RPI will end up paying more than they can actually afford when the rate falls again. What’s more, all those sensible types who were prudently putting money away for a rainy day while everyone else was loading up on debt are now faced with minuscule savings rates, and higher prices for goods. Doesn’t really seem fair, does it?

In today's bulletin:

Savers to suffer as inflation soars to 3.5%
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