The UK Consumer Prices Index (CPI) measure of inflation for August 2018 rose to 2.7%, the Office for National Statistics (ONS) revealed this morning.
In July, the inflation rate was 2.5%, so it seems to be on the rise.
Which? explains why inflation has risen, and what effect this could have on your savings.
Why has inflation risen?
CPI inflation tracks the cost of an imaginary ‘shopping basket’ of more than 400 popular goods and services, such as flights, milk, alcohol and fuel.
The figures show how much the overall price of this basket has increased or decreased since the same time the previous year.
The main drivers behind August’s inflation jump are transport costs – particularly motor fuels – which have risen by 6% since last August, and are at their highest since April 2017.
Prices for recreation and culture have increased by 3.6% since last year, with package holidays being the largest contribution.
While a downward contribution from reduced prices for furniture, household goods and telecommunications, these were not enough to offset other price rises.
The graph below shows how CPI inflation has changed over the last five years, peaking at 3.1% in November 2017.
The Bank of England is responsible for keeping inflation as near to 2.0% as possible, and will adjust the base rate to help hit this target.
In theory, a base rate hike encourages banks to increase rates for loans, mortgages and savings. As people pay more on debt, and are rewarded for saving money, they become less inclined to buy goods and services – causing inflation to fall.
The Bank of England base rate was increased to 0.75% in August.
However, over the subsequent month, we found that many banks have upped their mortgage costs but failed to pass on the full rate increase to savers.
This could explain why a rise in the base rate has not had a desired effect in reducing inflation.
What effect does inflation have on savings?
If you have cash savings, it’s important to earn interest that can match or beat the rate of inflation.
If not, items will continue to get more expensive and, over time, your savings will end up being able to buy less.
So, if your current savings account is offering a rate less than 2.7%, you might want to consider switching to one that pays higher interest.
At the moment, inflation-beating rates can only be found from longer term fixed-rate savings and cash Isa accounts.
- Find out more: How to find the best savings account
Can any accounts beat inflation?
The table below shows the top rates being offered by instant-access fixed-rate savings accounts and cash Isas. Currently, only one account offers a rate equal to August’s inflation.
|Account||AER||Minimum initial deposit|
|Charter Savings Bank 5 Year Fixed Rate Bond||2.70%||£1,000|
|Shawbrook Bank 5 Year Fixed Rate Cash Isa Bond||2.15%||£5,000|
|Vanquis Bank 4 Year Fixed Rate Bond||2.52%||£1,000|
|Hodge Bank 4 Year Fixed Rate Cash Isa||1.80%||£1,000|
|Charter Savings Bank 3 Year Fixed Rate Bond||2.41%||£1,000|
|Paragon 3 Year Fixed Rate Cash Isa||1.86%||£500|
|PCF Bank 2 Year Term Deposit||2.25%||£1,000|
|Al Rayan Bank 24 Month Fixed Term Deposit Cash Isa||1.80% (EPR)*||£1,000|
|My Community Bank 12 Month Fixed Term Deposits||2.10%||£1,000|
|Al Rayan Bank 12 Month Fixed Term Deposit Cash Isa||1.60% (EPR)*||£1,000|
|Coventry Building Society Limited Access Saver||1.40%||£1|
|Al Rayan Bank Instant Access Cash Isa||1.35% (EPR)*||£50|
Source: Which? Money Compare. Correct September 2018. *Expected Profit Rate
Which savings account is best for you?
As the table shows, savings accounts currently offer significantly higher rates than cash Isas.
We recently wrote about the drop in the number of people taking out cash Isas, and poor rates are likely the cause. In fact, no cash Isas can beat the current rate of inflation.
For an inflation-busting rate, you’d need to opt for a four- or five-year bond.
But this is not to be entered into lightly – once you deposit your money, you will not be able to access it again until the full term has finished.
Some accounts will allow you to make withdrawals early, but will apply penalties that eat a large chunk of the interest earned.
If you have a large amount of savings, you may still want to consider paying it into a cash Isa.
The main advantage is that money held within Isas is tax-free – but bear in mind you can only pay in up to £20,000 in each tax year, and some other rules apply.
If you’ve earning interest from a savings account, your personal savings allowance will dictate how much profit you can earn before paying tax. Basic-rate taxpayers have an annual personal savings allowance of £1,000, while higher-rate taxpayers have a £500 allowance. Additional-rate taxpayers must pay tax on all of their savings interest.
The Which? Money Compare comparison tables let you search hundreds of savings and Isa accounts to help find the best account for you.
Save with Which? Recommended Providers
Which? Recommended Providers are companies that have been rated highly by the respondents to our unique customer survey and have products that meet the high standards of our researchers.
RCI Bank’s 2 Year Fixed Term bond pays 2.11% AER, requiring an initial deposit of £1,000, and you can save up to £1m. The bank has an overall Which? Customer Score of 77%, and is rated highly for its regular contact and customer service.
Coventry Building Society is another recommended provider. Its Limited Access Saver pays 1.40% AER, and you can open the account with just £1.
However, bear in mind that you’re only allowed to make three withdrawals each year – any more than this will incur a charge equal to 50 days’ interest on the amount withdrawn.
Which? Limited is an Introducer Appointed Representative of Which? Financial Services Limited, which is authorised and regulated by the Financial Conduct Authority (FRN 527029). Which? Mortgage Advisers and Which? Money Compare are trading names of Which? Financial Services Limited.