Since March 2009, annual inflation, as measured by the Retail Prices Index (RPI), has been in negative territory. This is a far cry from the 5% peak it reached in September 2008.

The September 2009 annual inflation figure, due out in mid-October, is likely to be around -2%, ie a fall in prices of 2p in the pound over the last 12 months.

Negative RPI inflation is already creating a few oddities:

• Train companies will have had to cut their regulated fares by 0.4% from next January, because their ticket prices are RPI-linked.
• In the spring Budget the Chancellor took the precaution of confirming that the basic state pension would rise by 2.5% from April 2010 rather than, as is the usual case, in line with the RPI. Tellingly, he made no commitment about the other benefits – including other state pensions – that are generally linked to the RPI.
• Student loans for those who started their courses before 1998 will carry a negative ‘interest rate' of 0.4% for the year to 31 August 2010. So, if no payment is made on a £1,000 debt at 1 September 2009, it will be £996 a year later. As mentioned above, for more recent students, the government has put a block on the ‘interest rate' falling below 0%.

If you are thinking ‘This Alice-in-Wonderland – inflation hasn't disappeared', you are at least partly right. The RPI is showing a year-on-year fall only because of the drop in mortgage interest payments. These have fallen sharply as bank base rates have declined from 5% (early October 2008) to 0.5% (since 5 March 2009). Strip out the mortgage interest effect from the RPI and you add about 2.5% to the inflation number, bringing it back above +1% and closer to the Government's other inflation measure, the Consumer Price Index (CPI, up1.8% for the year to July).

Of course, if and when we get back to a more normal pattern of interest rates, the whole process will go into reverse and the RPI will rise faster than the CPI (which for now excludes housing costs). In any event the RPI is likely to start rising in 2010 as the year-on-year change in mortgage interest costs shrinks and VAT increases.

The lesson from all of this is that inflation is still a factor that needs to be built into your financial planning. This is particularly true on the pension front. For a man aged 65, an inflation-proofed pension annuity still costs over 60% more than a fixed pension. For a woman aged 60, the difference is almost 80%.

ACTION

Some economists now see inflation as a major risk, so make sure that your financial plans do not ignore it.

Don't think nothing is changing - if inflation can move from +5% to -2% in the space of twelve months, the opposite is also true.

 

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