Inflation is rising at a rapid rate in the UK. In fact, according to the latest figures, it surged to 5.4 per cent at the end of 2021 – its highest level in nearly 30 years.

The sudden increase in inflation can, in part, be put down to the pandemic and its impact on costs within businesses and international trade, which is fuelling a crisis in the UK.

The latest data from the Bank of England (BoE) suggests that the higher price of fuel, clothes, food and many other everyday essentials have a large part to play in this unexpected and rapid rise in inflation.

Unfortunately, the trend suggests that inflation will continue to rise at unprecedented levels, with the BoE expecting the consumer prices index (CPI), by which inflation is measured, to rise to six per cent by April this year.

Some analysts have even said that this prediction is too conservative and that the rate for April may be nearer to seven per cent unless the Government takes action to support people with the cost of living, particularly their energy bills.

Of course, the BoE has already acted by increasing the base rate to 0.25 per cent from 0.1 per cent in December. Unfortunately, for those with debts, this may mean that they face higher costs over time as the banks increase their interest rates.

Clearly, there is great concern about the current rate of inflation, but how does it affect personal finances and what can savers and investors do to counter this?

Erosion of purchasing power 

One of the key net impacts of rising inflation is that it kills the purchasing power of individuals and businesses.

It means that the pound in your pocket (or more likely your bank account) is effectively worth less in future – you will not be able to purchase as much with the same amount.

For those who have saved their entire lives and built up a nest egg, it simply means that their money will not go as far.

If you budgeted £50 a week to cover your groceries this amount could now be £60 because the value of goods has increased.

Over time this erodes the income you derive from pensions and/or investments, giving you less purchasing power.

Currently, inflation is far out-pacing interest on most saving accounts. The more rapidly inflation rises, the quicker your purchasing power declines and the more income you need to meet your costs.

Loss of savings

Tied to the erosion of purchasing power is a speedier loss of savings. As we pay more for the items and services we purchase, our pool of money set aside inevitably shrinks more quickly.

With most people’s saving gaining 0.5 per cent interest at best, and inflation potentially due to hit seven per cent under some forecast, savers could be losing out at a rate of six and a half per cent.

This means that the rate at which you spend your savings increases more rapidly over time, and you may find that your original plans for wealth and retirement need to be reviewed.

Some savers may even fall foul of what is known as the money illusion during periods of high inflation, where they judge their wealth based on older estimates and preconceptions – effectively lying to themselves, often without realising, about how well off they are.

To prevent overspending of pension pots and savings, you need to account for inflation when setting future goals, spending and nurturing your investments.

Be cautious 

During periods of high inflation, it may be best to be a little more cautious with your approach to spending, investing and debt.

As interest rates rise to combat inflation, so does the cost of variable-rate debt, such as credit cards, overdrafts and non-fixed mortgages.

If you don’t keep an eye on this, payments will increase each month, eating into your income and savings.

One way to combat this is to pay off as much debt as possible, but this isn’t always possible due to the liquidity of the assets you own.

Instead, it may be cost-effective to switch to fixed-rate debts, such as a fixed-rate mortgage or credit card. This will tie you into the current rate but may prevent you from getting stung if rates rise rapidly.

Life, income and home insurance are two other areas that individuals may want to revisit.

Higher inflation often translates to higher home prices and rising wages. You must make sure that existing policies cover these increases so that they offer sufficient protection to you and your family.

Another area that should be reviewed closely is fixed-income investments like government bonds. Historically, these do not perform well during a period of rising or high inflation.

This is because most low yields on bonds can’t keep pace with inflation and, as interest rates rise, their value falls.

The one caveat to this is that newly issued bonds could have higher interest rates with a higher yield, which may be worth exploring.

Is it possible to protect wealth and savings against inflation? 

As with most things in finance, it often comes down to careful and regular planning.

Although inflation is making it more challenging to invest and save, it doesn’t mean that you should abandon all plans and take your money out of the bank.

Instead, savers and investors need to adapt their current wealth, protection, and pension plans to find the best deals, that if not beating inflation, at least keep pace as best as they can to prevent the erosion of hard-earned income.

Rather than waiting for things to improve, now is the time to be seeking financial advice so that you have the best possible chance of retaining wealth through effective investment and saving strategies.

If you need assistance with weathering the storm of high inflation, please speak to us.