Inflation in the UK hit heights of 11.1% in October last year, creating a big strain on our purse strings. However, this has fallen to 6.7% in August and September this year. See figures underlined in orange below:
The Bank of England say they expect inflation to fall further in the coming months, with predictions of a rate of around 5% by the end of the year.
They also expect inflation to continue to fall in 2024, reaching the target rate of 2% in the first half of 2025.
It is important to note here that a fall in inflation (disinflation) does not mean goods and services are getting cheaper (which would be deflation). It simply means that the rate of inflation is decreasing, so costs are still rising, it’s just happening more slowly.
Food Costs
The rate of inflation for food and non-alcoholic beverages is much higher than the average overall inflation rate. This is because the inflation rate is an average, and the prices of different goods and services rise at different rates.
48% of Great British adults say they have spent more than usual to get their usual food shop within the last two weeks.
However, the inflation rate for food and non-alcoholic beverages has eased to 12.2% in September this year, acting as a decrease from 13.6% in August and from highs of 19.2% in March.
Why is Inflation Falling?
One key reason why the Bank of England expect continued disinflation is that energy bills should reduce more due to recent falls in gas prices.
They have also stated that higher interest rates will help bring down inflation further. This is because higher interest rates discourage spending by decreasing the cost of borrowing and increasing the reward of saving money.
What About Wages?
In June to August 2023, annual growth in regular pay for the public sector was 6.8%, acting as one of the highest regular annual growth rates since 2001. However, this rise was 8% the private sector, meaning there remains a gap between public and private wage increases.
Importantly, data from The Office of National Statistics (ONS) shows a positive annual growth rate in real pay for August 2023 (real pay accounts for inflation). This is certainly much needed to help reduce some of the pressure on household budgets among the continued cost-of-living crisis.
The Bank of England (BoE) is looking into the creation of a digital pound that could be used for in-person or online purchases, acting as an alternative for (but not a replacement of) cash.
The Digital Pound
The central bank digital currency (CBDC) or ‘digital pound’, would use some of the same technologies as cryptocurrency. However, it would be different in nature as it would have a central regulator (BoE) and its value would be denominated in pound sterling, rather than being entirely demand and supply driven.
From the above graph, taken from page 9 of said paper, we can see the decline of cash use in recent years, combined with an increase in card purchases.
Therefore, introducing digital money could be a way to take into account these consumer trends.
Perhaps here we can link the impact of Covid-19. During the height of the pandemic, we saw many businesses unwilling to accept cash payments due to it being less sanitary. Perhaps this has now stimulated a change in consumer purchasing wherein we are now less likely to resort to cash because we saw the ease of which we could live without it.
BoE has stated, “while we ensure continued access to cash, we also have to recognise that it cannot be used in digital transactions.” The proposed digital pound is not intended to replace cash, but rather to act as an alternative when cash cannot be used, or when consumers do not wish to use it.
Critcism
Moody’s Investors Service have argued that CBDCs would disrupt traditional banks. This in turn could lead to closure of branches and job losses as a result, due to the shift in the power structure of financial institutions.
Lord Forsyth of Drumlean, Chair of this Committee, stated, “We took evidence from a variety of witnesses and none of them were able to give us a compelling reason for why the UK needed a central bank digital currency. The concept seems to present a lot of risk for very little reward. We concluded that the idea was a solution in search of a problem.”
The ICAEW also stated that, “the shift in banking practices away from consumers holding money in cash form or as commercial bank deposits carries potentially seismic risks from a financial stability and monetary policy perspective.” However, BoE aims to address the risk to financial stability by setting deposit limits of £10-£20k in order to reduce money flows from commercial banks.
As you can see, the digital pound is certainly not an uncontested idea, as many have concerns about its potential repercussions. Perhaps one of the largest concerns from the public is about potential breaches of privacy…
Privacy
In response to these privacy concerns, BoE states that the digital pound would be “subject to rigorous standards of privacy and data protection.” They have proposed a platform model wherein Payment Interface Providers would identify and verify users but then anonymise this personal data before sharing information with the Bank. Therefore, neither BoE nor the Government would have access to users’ personal data, except for in exceptional circumstances whereby law enforcement agencies would be legally entitled to. This proposed system would therefore work similarly to current digital payments and bank accounts.
The digital pound is currently a consideration rather than an actuality. BoE is continuing to look into whether progression will take place in order to build and launch the digital pound.
by Red Star Wealth
With the Bank of England’s emergency bond buying support set to end today (Friday 14th October), we think it’s important to fill you in on what exactly has been going on.
The Mini Budget
Kwarteng’s mini-budget on 23rd September 2022 saw the Government announce enormous tax cuts with very little explanation as to how these would be funded. This has triggered strong waves of uncertainty which have in turn affected the UK’s financial situation.
It led to a steep drop in the value of the pound as well as rises in government borrowing costs.
Government Borrowing
One of the ways in which the Government generates enough money to fund its spending plans is by selling government bonds (also known as gilts) to investors. This acts as a form of debt which is paid back over time with the addition to interest.
They sell these bonds to investors such as large pension funds and big banks on international markets.
These investors have been demanding much higher interest rates to lend to the UK government because they have concerns over whether their tax cut plan will actually work.
What is the Link with Pension Funds?
Pension funds tend to invest in bonds as they are seen as a low-risk investment, giving a low but reliable return over a long period of time. They also buy a form of insurance to protect the value of these bonds.
As government borrowing costs increased, insurance providers began charging a higher rate of interest.
In order to afford these extra payments, many pension funds began selling their bonds, with further reduced their price and pushed up their interest.
This created a negative spiral, as the more bonds pension funds sold, the higher the cost of government borrowing became, meaning insurance payments rose, meaning even more bonds were sold, and so on, and so forth.
Bank of England Emergency Intervention
The Bank of England (BoE) decided to implement an emergency bond buying scheme as a temporary measure to stop the prices of government bonds falling any further and thus limit the need for pension funds to sell any more of them.
It did this by buying lots of government bonds. By buying these bonds, government borrowing costs should reduce, as it eliminates the need to pay those huge interest rates demanded by investors we mentioned earlier.
By buying these bonds, the BoE has helped stabilise their price, preventing further sales from pension schemes that could ultimately cause their collapse. They have essentially halted the market turmoil that was putting pressure on pension funds.
Despite announcing that they would buy up to £65bn bonds, with a daily purchase limit of £5bn a day, they have only bought around £5bn in total.
Only a Temporary Measure
The BoE’s intervention is a temporary measure aimed at maintaining financial stability. Their bond-buying scheme is due to end today, despite pension funds trying to get them to extend their intervention.
On Wednesday, when they announced that their emergency support would end on Friday as planned, the price of 20-year UK bonds hit new lows, with interest rates going up to levels not seen since 2002.
However, the idea behind the BoE stopping their intervention is that they expect demand to increase as pension funds rebalance their portfolios and stabilise. Think of the measure of them allowing pension funds some time to get back on their feet.
The BoE has not completely withdrawn support either. They have announced further measures to help pension fund sthat have been negatively affected by the recent market volatility. Under this measure, funds will be able to use a wider range of assets to access money to meet short-term financial needs. This should mean less pension funds having to turn to selling government bonds to raise cash, which is what was happening after Kwarteng’s mini-budget.
What a mess! If you’re still worried about what this means for you and your pension, reach out to a financial adviser for help.
by Red Star Wealth
Though the Bank of England has not officially predicted a recession later this year, it is looking increasingly likely. This is due to the huge increases in the rate of inflation and the labour shortages continuing from Brexit and Covid. Here are some ways of preparing your personal finances in case a recession takes place.
Save, save, save
It may be a good idea to start building up your savings account, wherever possible. Having a strong emergency fund means you are prepared for unexpected costs. You never know what’s round the corner so it is best to prepare for the worst and expect the unexpected.
For example, your income may reduce from either losing your job or having your hours cut down due to less consumer demand in the economy. This would make essential payments harder to deal with, especially those arising out of the blue, such as your car breaking down or your bills rising (the latter being incredibly likely at the moment).
Go Debt Free
Try to pay off existing debts wherever you’re able to. Consider making a debt repayment plan… this could involve paying off priority debts first, before focussing on the ones with the highest interest rates in order to save money on interest repayments.
Priority debts are things like gas and electric bills and mortgage arrears (missed mortgage payments). These debts should be prioritised as they have the potential to cause the most issues, such as having your electricity cut off, or losing your home.
Avoid taking on any extra debts as you don’t want the amount you owe to become unmanageable
Shop Around
You can try to reduce your expenses by switching to cheaper options. Even though switching accounts can be a pain, it’s worth it in the long run.
If your weekly shop costs a bomb, maybe try to find a cheaper supermarket and cut down on certain luxury goods. If there’s ever a time to be frugal it’s now.
Avoid Investment Panic
Don’t let panic affect your investment choices. You shouldn’t let emotion cloud your judgement. Your investments dropping in value in the short-run during a recession does not mean they lack long-run profitability. For more info on this, check out this previous blog on the importance of long run investment.
It’s also worth considering diversifying your investments now so that one industry facing a decline during recession doesn’t sink your whole portfolio.
by Red Star Wealth
We all hear the word ‘inflation’ so much that you’re probably sick of it. However, stagflation seems to be a topic less talked about. With the risk of stagflation having increased in the UK, we think it’s important to have a quick rundown of what this actually means
The Different Types of ‘-flation‘
Inflation- a general rise in prices, meaning you get less for your money
Disinflation- a fall in the rate of inflation. Prices are still rising but at a slower rate
Deflation- a general fall in prices
Stagflation-persistent high inflation, coinciding with high unemployment and slow economic growth. It is a combination of both ‘stagnation’ (slow growth, no wage increases and high unemployment) and ‘inflation’
Stagflation is a Rareity
Until the 1970s, most economists shared the belief that inflation and unemployment have an inverse relationship. This means that when inflation increases, unemployment tends to decrease. However, we now know this is no longer the case
What Happened in the ’70s?
We haven’t faced stagflation since the 1970s. This economic situation was caused by the oil crisis acting as a supply shock
The oil crisis meant the UK and US could no longer import oil from the Middle East. Continued strong demand with a huge restriction on supply meant that oil prices shot up by a whopping 300%
Demand and supply diagram by Red Star Wealth
As shown by the above diagram, when supply restricts, prices are pushed up
What Causes Stagflation?
Supply-side shocks, such as labour shortages or the example of the 1970s oil crisis
Certain fiscal and monetary policies, e.g, government spending being too high, or interest rates being too low
What Would it Mean for Us?
Stagflation would hit the average UK household hard; it would mean people’s wages weren’t keeping up with the price increases of goods and services
It would essentially be a worsening of the current cost-of-living crisis
Once it starts, it is difficult to reverse
Managing inflation involves a reduction of the flow of money to reduce inflationary pressures caused by high demand. For example, the recent government decision to raise the interest rate to 1.75% is a way of trying to counter inflation
On the other hand, managing a recession usually involves an influx of money into the economy to kickstart economic activity and encourage spending. Part of this could be lowering the interest rate
Given that stagflation is a combination of both of these, it is very difficult to solve, as these are two completely opposite approaches
Stagflation can be dealt with by dealing with the supply-side shock that caused it as quickly as possible. Then, action should be taken to reduce inflation before dealing with the stagnation aspect
Will we enter a period of stagflation?
In its latest Financial Stability Report, The Bank of England has said the outlook of the UK economy “is subject to considerable uncertainty”. Click here to read the full report.
As discussed in one our previous blogs, inflation is estimated to reach 13% later this year, meeting the first condition of stagflation
However, the UK’s GDP actually rose by 0.5% over the 3 months preceding April this year. This said, this growth could certainly end up being negated if there is a drop later this year caused by the cost-of-living crisis reducing spending. Additionally, whilst our unemployment rate is actually low, there are still labour shortages caused by Brexit and Covid reducing the size of our labour force
However…
The average inflation of Great Britain in 1975 was an enormous 24.11% so we aren’t in the same boat yet
We can’t predict for certain exactly what will happen to the economy. At the end of the day, we aren’t psychics or oracles! All that this info means is that the risk of stagnation has increased, not that it is inevitable and unavoidable
by Red Star Wealth
With the cost of living constantly increasing, it can be difficult to understand why the Bank of England has chosen to increase interest rates. Why increase the rate of interest when this will make mortgages more expensive? Join us as we investigate why this is the case
What is inflation?
Inflation is when an economy’s goods and services see a general increase in price. The rate of inflation is a measure of the speed of this increase; a higher rate of inflation means prices are generally increasing quicker
Inflation reduces the purchasing power of consumers’ money. In a nutshell, they get less “bang for their buck”
What is disinflation?
Disinflation is when the rate of inflation is reduced. This is the current aim of the Bank of England. In order to keep inflation stable, they aim to keep it at a rate of 2%
Source: Office for National Statistics
The CPIH is the Consumer Price Index, taking into account housing costs
As you can see from the above figure, inflation is currently far above this target. In fact, the Bank of England has predicted that the rate of inflation may reach over 13% this year
For those who wish to look further into the changing inflation rate over the years, we recommend checking out the Office of National Statistics
Measures must be taken to reduce this inflationary pressure… this is where the increased interest rate comes into play
The effect of interest rates on inflation
By increasing interest rates, the Bank of England is aiming to discourage consumer borrowing and encourage consumer spending. By saving more and thus spending less, the idea is that there will be less inflationary pressure stemming from consumer demand
On the 16th June 2022, the Bank of England’s base rate of interest rose from 1% to 1.25%. As of the 4thAugust 2022, this has increased to 1.75%, serving as the biggest rise in the last 15 years
What does an increased interest rate mean for you?
Mortgage rates will increase for any homeowners that aren’t on fixed rate deals
You will have a higher rate of interest on your savings, meaning more money in the account. However, inflation is still eating away at the purchasing power of money so it is still reducing in value
You will have a higher payments for money borrowed on credit cards or loans
One of the main drivers of inflation is the increase in price of wholesale gas prices, of which higher interest rates will not bring down
A recession?
A recession is when there is a prolonged downturn in economic activity for two or more consecutive quarters (each quarter being 3 months long)
The Bank of England has warned that we are likely to enter a recession later this year, which is predicted to last as long as 5 quarters
Whilst this all seems like a very grim outlook, there are ways of dealing with these difficult times. Check out this blog for help in managing your finances during a recession
