How to beat rising prices

Inflation jumped to 5.5% this month. What can you do to fight back?

Inflation jumped to 5.5% this month and many people think that it’s the biggest economic threat we’ll face over the next few years.

So what is inflation and how can we protect ourselves against this danger?

What is inflation? 

Basically, inflation measures rising prices.

The current rate is 5.5% so that means that prices have gone up by 5.5% on average over the last year.

Things get more complicated when we look at what causes inflation. This is a really controversial  subject, but, as far as I’m concerned, there are two main causes: 

More money 

If there’s more money flowing around in an economy, you’d normally expect inflation to rise. Here’s why: 

Imagine you’re on a desert island with nine other people. You all do different jobs on the island and buy services and goods from each other. Three people hunt, two cook, one builds shelter, and so on. 

You use bottle tops as your ‘currency’ on the island. At the moment, there are 50 bottle tops on the island and there’s a well-understood price list for different things. A dead rabbit, for example, sells for 2 bottle tops. 

Imagine that one person suddenly discovers 20 extra bottles  in the wreckage of a crashed plane. Suddenly there are 70 bottle tops on the island, and at least one inhabitant will be able to pay more for a rabbit. Prices will rise. 

If a government dramatically increased the supply of money in an economy, perhaps by printing extra notes, you could expect to see the same phenomenon. All other things being equal, more money in the economy should lead to inflation. 

Higher costs 

The other main cause of inflation is rising costs. If a company has to pay higher wages, it will want to push up the prices of the goods it sells to cover the extra costs. The same thing happens if the price of oil or another commodity rises. 

What’s happening  now?

You may have seen two different inflation figures mentioned in the press. One measure is called the RPI (retail price index) and the other is called the CPI (consumer price index.) The government prefers to use the CPI, which is normally lower, but I prefer the RPI because it includes housing costs.

Right now, the RPI is at 5.5% while the goverment’s favourite, the CPI, is at 4.4% - well above the Bank of England’s 2% target. The main reason for that has been higher prices for oil and food. What’s more, the Bank of England has created lots of extra money since 2009.

I fear that inflation is going to stay high for the rest of this year and possibly longer. 

Trouble is, the rates on most savings accounts these days are low – even the very best instant access account is paying just above 3%. In other words, you’d still lose out to inflation if you put your money in this account

Become a regular saver

Donna Ferguson: "There are a few accounts out there that offer 8% or more, so they beat inflation but they're regular saver accounts, so you have to save regularly, you can't put in a lump sum and there are lots of terms and conditions attached.

"Another option is to go for a fixed rate bond or cash isa but even then you're unlikely to actually beat inflation, you might just about match it but  you're not going to manage to have a competitive rate all the time because rates might rise and your rate will be stuck and fixed at a set level."

Put your money in a fixed rate bond or ISA

Returns to Ed Bowsher:

You can get better returns with fixed rate bonds but even then, most products don't beat inflation but most products don’t beat inflation. If inflation continues to get higher, rates on fixed rate bonds and ISAs won’t rise.

Get an index linked product 

If you want to make sure that your money always keeps up with inflation, then an index linked product is an attractive option. If inflation soars to 20%, the rate you earn on your savings will soar too. 

Trouble is, index-linked savings products are very rare at the moment. I know of just two – they’re both offered by BM Savings. Let’s look at BM Savings’ 5 year inflation rate bond. You have the peace of mind of knowing that, for five years, your return is linked to inflation. You can’t access your money for that period, but each year, you’ll receive 1.5% plus the inflation rate for that year.

So if inflation is 3%, you’ll receive 4.5% in interest; if inflation is 20%, you’ll receive 21.5%. If inflation takes off, you won’t need to lose sleep. Your money will retain its value. What’s more, BM Savings uses the RPI measure of inflation, the one that currently stands at 5.5%.

BM Savings also offers a 3 year bond. It pays the rate of inflation plus 0.75%. So if inflation is 5%, you get 5.75%. It’s a lower rate than the 5-year bond, but you only have to lock your money away for three years instead of five.

No simple weapon

Sadly, it’s not easy to fight inflation but, more often than not, there are some inflation-busting weapons out there. You just need to know where to look.