The CPI measure of inflation for September came in at 1.7% according to the latest set of figures produced by the Office for National Statistics. This is the first time in three years the inflation reading has dipped below the Bank of England’s 2% target, and against the backdrop of a painful inflationary period it marks a welcome return to less rampant price rises.

We shouldn’t read too much into one month’s inflation figures, especially when October’s rise in the energy price cap could see CPI rising again. However, lower inflation does widen the path for the Bank of England to loosen monetary policy. Markets are now pricing in the base rate falling back to 4.5% by the end of this year, and 4% by the middle of next year, so it’s worth considering what this might mean for your personal finances.

CASH

Lower inflation is, on the face of it, good for cash savers, as it means the interest earned on savings goes further in terms of increasing your spending power. But if interest rate cuts materialise, they will feed into lower cash returns too, particularly for variable rate accounts. Nonetheless, cash savers still have their heads well above water when it comes to beating inflation with the best rates still offering around 5%.

That said, it’s future inflation and interest rates which will impact on the real return enjoyed by savers. We’re due an updated forecast from the Bank of England, but their last monetary report suggested inflation would be around 2.5% over the next year or so.

If interest rates fall in line with expectations, this will lead to a squeeze on the real returns enjoyed by savers in variable rate accounts. Given the outlook for rates to fall, the best deals for fixed term accounts still look pretty perky, and those who don’t need immediate access to their cash might consider whether it’s a good time to lock in current rates.

MORTGAGE RATES

As interest rates fall, mortgage rates can be expected to follow suit, which is of course good news for anyone stepping onto the housing ladder for the first time. Lower rates are also good for those remortgaging, but how borrowers feel about coming off their old deal will very much depend on when it was brokered.

Five-year fixes coming up for renewal will have been taken out in the fourth quarter of 2019, when a typical rate for a 75% loan to value mortgage stood at around 1.7%, according to Bank of England data. These borrowers might be in for a nasty rate shock, although unless they’ve been living under a rock they probably know what’s in store.

By contrast anyone coming off a two-year fix might well have set their deal in the fourth quarter of 2022, when Kwasi Kwarteng’s mini-Budget wreaked havoc in the mortgage market. Average rates for a two-year fix on a 75% loan to value mortgage hit 6% at that time, and some borrowers will have been stuck paying significantly more. Remortgaging in a market where the best two-year fixes are coming in under 4% might seem like sweet relief to these borrowers.

BONDS

Lower inflation is good for conventional bonds, as it increases the value of their fixed income streams and serves to lower expectations for interest rates, pushing prices up and yields down. In theory, gilt yields should reflect interest rate expectations over the term of the bond, so it’s not the case that an interest rate cut will necessarily produce a commensurate fall in bond yields.

However, if inflation continues to come in below expectations it would prompt markets to accelerate and deepen their forecasts for interest rate cuts, which would be positive for bond prices. Gilt yields have been rising in recent weeks, probably reflecting some jitteriness about the forthcoming Budget, which shows that government debt issuance and affordability also plays a part in government bond pricing, as do the Bank of England’s gilt sales, as it seeks to unwind quantitative easing.

Gilts are current yielding 4% at the two-year maturity, which doesn’t look too sharp for savers when you consider the best two-year fixed term accounts are yielding somewhere in the region of 4.5% according to Moneyfacts. However, the gilt yield starts to look more attractive for low coupon government bonds which offer a return which is almost tax-free, because gilts aren’t subject to capital gains tax. For example, a theoretical gilt yielding 4% delivered entirely through capital gains would be equivalent to an interest-bearing savings account paying 6.6% in the hands of a higher rate taxpayer who had used their Personal Savings Allowance, or 7.3% in the hands of an additional rate taxpayer. Little wonder then that low coupon gilts have been used as cash alternatives by wealthier individuals looking to manage their tax bill.

UK EQUITIES

Lower inflation is also good for UK equities as it means dividends and capital growth look more attractive in real terms. Like other assets, each percentage point of annual returns delivered now provides more bang for your buck when it comes to growing your spending power. A more buoyant consumer who is less constrained by inflation also spells good news for companies which sell discretionary items to UK households.

Limp economic growth and weak investor sentiment may continue to drag on the performance of the UK equities though. More money in consumer pockets combined with lower variable cash rates might persuade more individuals to invest in the stock market, though in recent times that’s meant more money going into global rather than UK funds.

‹ Previous2024-10-24Next ›