Rising UK inflation: what can you do to protect yourself?

UK inflation has been rising, overtaking average earnings growth and moving way above the interest rate. What can you do to protect your savings and investments in this environment?

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

The consumer price index (CPI) inflation measure hit 2.4% in April, having been below 1.5% in 2016 and 2017. That means it’s running ahead of both weekly earnings (2.4% annualised) and weekly earnings ex-bonus (2.1% annualised), so workers have received a real terms pay cut. 

The difference between CPI and RPI

There are two inflation indices in common usage in the UK: the Consumer Price Index (CPI) and the Retail Price Index (RPI). CPI was brought in to harmonise UK inflation data with the European Union (EU), and the Bank of England (BoE) targets a 2% rate. Prior to this the BoE targeted a 2.5% rate in RPI, which differs from CPI by including more housing costs such as mortgage interest payments, holiday spending abroad and building insurance.

RPI still has a valid role to play, as it is used to calculate the value of UK government inflation-linked bonds, but interestingly RPI excludes the top 4% of households by wealth, as well as pensioners on state benefits. This has led to claims that ‘real inflation’ from the likes of school fees and domestic help among the more wealthy and heating costs for less well-off pensioners - which may account for a larger proportion of their spending - is much higher than what is reported in the official numbers.

What does the long-term data show?

Using nominal wage growth data starting in January 2000, we can see that earnings have just about kept pace with the RPI measure of inflation, but have exceeded CPI by around 10%. On this measure, despite productivity gains, UK workers have not seen real wages increase by much, if anything at all, for the past 17 years.

Chart 1: UK nominal wages vs. inflation 

The chart disguises a distinct trend: in the years leading up to the 2008/09 financial crisis wages did outpace inflation.

In chart 2 we can see that post the crisis, global quantitative easing and banks tightening their lending practices has not been good for real wages.

In the past three years, much has been written about the consumer recovery. Certainly in terms of shopping, the BRC Nielsen Shop Price Index reports that store prices are 6.2% lower than they were in March 2013, and are at the same level they were in August 2008. Consumers have been able to buy more than before, for less.

However comparing nominal wages to RPI there is little evidence that consumers have had much to celebrate overall. Real wages bottomed in March 2014 and have barely recovered since then on an RPI basis.

Chart 2: UK wages relative to inflation

What can you do to protect your savings from inflation?

In the long run, cash deposits are not the answer. Looking at ten years to the end of March 2017, RPI inflation rose by 32.6%, while anyone receiving the BoE base rate would have made a total return of 13.5%. In other words, cash in a bank account has lost 19.1% of its real value in ten years.

The best way to protect your savings from inflation is to invest in real economy, and the stock market is the most cost-effective way to do that. Although equity markets are at new heights, regular investors can benefit from Pound Cost Averaging, where dips in the markets allow the patient investor to pick up more stock at a cheaper price.

Watch Andrew Craig, author of ‘How to Own the World’ explain how inflation affects savings

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