apple and money showing inflation

With interest rates failing to keep up with inflation, the value of your savings is slowly eroding as the cost of living rises.

If you put £100,000 in savings that offers 1% interest, you will earn £1,000. However, that £1,000 isn’t quite what it seems.

Take the current inflation, 10.4% (as of 11th May 2023) for example. At that rate, after one year, your £100,000 pot adjusted for inflation would be worth £89,600. So technically, you would lose money.

In other words, the purchasing power of your cash has been eroded, even when you add the £1,000 earnings. Over the long term, this really adds up.

And you will probably pay tax on the interest you’ve earned even though the value of your capital has actually reduced.

The calculations are quite alarming. However, in this blog post we will share our advice on how inflation affects your money and what your options are to reduce this impact.

What is inflation?

Inflation is the rate at which prices are rising over time. if a loaf of bread costs £1 and that rises by 10p, then bread inflation is 10%. This causes a decrease in the purchasing power of money. It means that, on average with the same amount of money you will buy fewer goods and services in the future than it would today.

Since February 2021, prices have been rising quickly, starting from a CPI rate of just 0.4%. Several factors have contributed to this upward trend, including heightened demand following the pandemic, delays in supply chains, the impact of Brexit regulations, the ongoing conflict in Ukraine, and a surge in gas prices.

The Bank of England have previously warned that inflation could reach a peak of 13%. In November 2021, it hit 11.1% and had been gradually decreasing thereafter. However, in February it shot back up to 10.4%. Fortunately, inflation is once again on a downward trajectory.

According to the Office for Budget Responsibility, inflation is expected to decrease to 2.9% by the end of 2023. Additionally, there are positive indications that the UK will avoid a recession this year, suggesting that we may have surpassed the most challenging phase of the cost-of-living crisis.

How is inflation calculated in the UK?

The Office for National Statistics (ONS) conducts a monthly collection of approximately 180,000 prices from around 700 items. This extensive data gathering is then used to calculate the Consumer Prices Index (CPI), which serves as a measure of inflation.

To ensure the CPI accurately reflects our current spending patterns, the contents of the “shopping basket” are regularly reviewed and adjusted. In line with changing consumer habits, the ONS has made some revisions this year. Notably, alcopops and non-chart CDs have been removed from the list, while e-bikes, home security cameras, and frozen berries for making smoothies have been added to reflect evolving preferences and trends.

How does inflation affect you?

According to the Bank of England, inflation should be at 2%! Here are some of the ways inflation may affect you:

  1. Savings: With interest rates failing to keep up with inflation, savings are slowly eroding with the cost of living, meaning you lose 10.4% of your savings.
  2. Wage Pressures: When prices rise, employees often demand higher wages to cover their increased living costs. As an employer you may be hesitant to give raises or may struggle to afford them due to increased costs for raw materials and other business expenses, creating wage pressures.
  3. Pensions: Inflation can eat away at the value of fixed pension payments, decreasing their purchasing power over time. This can affect retirees’ ability to maintain a comfortable lifestyle during retirement. If you hold a lot of your investments in cash, with high inflation eroding savings, you will need to consider investing this money.
  4. Interest Rates: Central banks often raise interest rates in an attempt to manage inflation levels. Higher interest rates might reduce your disposable income by increasing your mortgage or loan repayments while reducing overall spending in the economy.
  5. House Prices: Inflation can sometimes lead to increased demand for housing, pushing up house prices. However, prolonged periods of high inflation might also cause house price declines due to decreased affordability.
  6. Cost of Living: As previously mentioned, inflation reduces purchasing power and increases the cost of living. This means you’ll need more money just to maintain your current lifestyle.

How to get the most of out your money during high inflation

Here are some strategies to consider for getting the most out of your money during high inflation.

1. Tailor your Treasury Management strategy

Treasury management is all the activities and processes involved in managing a company’s money. This includes tasks such as cash flow forecasting, investing, risk assessment and day-to-day operations like banking and invoicing. It is a crucial place to start when planning your business or personal finances.

By actively monitoring and managing your cash flow, investment, debt levels and risk exposure you can optimise both short-term and long-term returns.

2. Consider paying off you mortgage early

If you have funds sitting in a savings account or tied up within your company, rather than this depreciating, you could consider taking this money out and paying off your mortgage early. However, drawing funds from your company is likely to trigger as tax liability so it’s important you speak with a tax expert to ensure the benefits outweigh the tax costs.

Paying off your mortgage early may also cause early mortgage repayment penalties. It’s important you check your mortgage agreement to see if there are any prepayment penalties or restrictions before making any additional payments.

If there are penalties involved, compare the cost of these compared to the amount of interest you’d save paying early, and how much your savings would be eroding if sat in a savings account. This will help you determine whether it’s still a profitable option.

3. Buy business premises or invest in property

Owning property allows you to build equity over time and can save you money in the long run by reducing or eliminating rent costs, it will also give you another venue stream if you rent this out. This a good way to investing money you have sitting in a savings account.

4. Use your pension to buy property for your business or other assets

An alternative way to maximise this investment is to use your pension to buy property or other assets that don’t have any kind of personal benefit to them. The most common method of doing this is using a Self-Invested Personal Pension (SIPP).

With a SIPP, you can invest in:

  • Commercial property
  • Stocks and shares
  • Investment trusts listed on any stock exchange
  • UK government bonds, plus bonds issued by foreign governments
  • Open ended investment companies which are recognised by the Financial Conduct Authority
  • Gilts and bonds
  • Exchange traded funds traded on the London Stock Exchange or other European markets
  • Bank deposit accounts including non-Sterling accounts
  • Real estate investment trusts listed on any stock exchange
  • Offshore funds

There are many ins and outs of investing using a SIPP, which we go into more detail on this article.

Protect your business during high inflation

Inflation is beginning to fall in the UK steadily so the future is looking brighter. If you need any help to help your business through this and the challenges ahead with the increased burden of taxation on small businesses, we can help. 

Book a free consultation with one of our advisers and find out how we can help you.  

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