What deflation means for RateSetter investors
By Luke O'Mahony | Fri 5 Jun 15
By Luke O'Mahony | Fri 5 Jun 15
Fortunately, wages tend to rise each year too, although not necessarily at the same rate. The phenomenon of sustained price rises is called inflation, and it usually sits at around 2% per year, meaning that a given product will cost 2% more in a year’s time than it does today.
The measure of inflation that the Government uses is the consumer price inflation (CPI), which measures the value of a ‘basket’ of goods – that basket is weighted to represent our typical spending, so it might include cinema tickets, milk and selfie sticks depending on what we’ve been buying recently – there’s a good official guide to this here, and a slightly more entertaining one on the Guardian's website. As an aside, if you want to know how significantly inflation will affect you personally based on your own spending habits, you can calculate it for yourself on the Bank of England's website.
If you’re a saver or an investor, inflation can be a problem: if you invest £100 at an interest rate of 1% per annum, the fact that anything you might care to buy will be 2% more expensive a year down the line means that purchasing power of your money will have actually fallen. Thankfully, lending returns on all RateSetter products have consistently outperformed inflation over the last year – unfortunately the same can’t always be said for riskless assets such as cash savings accounts.
Recently though, something unusual has been going on. Instead of prices going up, for the first time in 50 years, the Office of National Statistics announced that prices had actually fallen by 0.1% and the UK had entered a period of deflation. If that sounds like good news for savers and investors, that’s because it is – up to a point. Deflation has the opposite effect of inflation, meaning that you can buy more for the same amount of money, so in effect, your savings and investments are boosted in value.
The most surprising thing about deflation is that people don’t know that it is happening: figures released by the Bank of England today show that on average, people think that the current rate of inflation is 2.2% - a long way off the real figure of -0.1%.
It’s not all sunshine and rainbows though: many economists see deflation as a sign of trouble in the economy – a bad omen in general. There’s a risk that consumers will put off purchases (why buy today when the same product could be cheaper next month?) and the lack of demand will hinder growth and investment. They’ll point to Japan’s once prosperous economy, which has been stuck in a long cycle of deflation and low growth, and argue that a small amount of inflation (usually around 2%) is a sign of a healthy, growing economy.
In fact, the Government sees moderate and stable inflation as a good thing – the Bank of England aims to hit an inflation target of 2%, and it must write a letter to the Chancellor (George Osborne) to explain itself if inflation is more than 3% or less than 1%.
For savers and investors, deflation is a good thing, at least in the short term. Inflation eats away at your investments – whether these are stocks and shares, money in the bank or even cash under the mattress – but deflation increases their value. To find out more about our lending products, head to our lending page, and if you want to see how our rates compare to inflation, we’ve got a handy chart here - scroll down to see stats for the last five years.
Do you factor in inflation when you’re investing? How long do you think it’ll take for inflation to rise back up to 2%? Let us know in the comments section below.
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