What falling inflation means for savers, borrowers and investors

What financial decisions should you make now that inflation is seemingly under control?

UK inflation finally seems to be under control with the latest official figures revealing prices rose a comparatively modest 3.2% in the year to March 2024.

While this is still well above the Bank of England’s 2% target, it’s a far cry from the eye-watering 11.1% it reached in late 2022.

But what does this mean for your finances? How can you make the most of this increasingly benign economic environment and what pitfalls must be avoided?

We take a look at what lower inflation means for savers, spenders, investors and those looking to climb on – or up – the property ladder.

What's happening with inflation?

First, a bit of background. Inflation is a measure of how much prices of goods and services have gone up over time, expressed as a percentage.

The ideal scenario is for inflation to be low and stable. That’s why the UK Government requires the Bank of England to keep inflation at 2%.

Unfortunately, inflation soared during 2021 and 2022 due to factors such as global supply chain pressures in the wake of Covid-19 and Russia’s invasion of Ukraine.

However, a series of interest rate hikes have succeeded in taking the steam out of the overheating economy and a return to normality looks more likely.

Nothing is guaranteed but the Bank of England expects prices to rise more slowly than they have done in recent years – unless there is another global shock.

“We can’t predict exactly what will happen to inflation in the future,” it stated. “It could fall slightly under 2% for a short while in the spring, before rising a bit in the second half of this year.”

When inflation is under control interest rates will start to fall from the 5.25% level that they’ve been at since August 2023.

So, what should you be doing now with your money to prepare – and what can wait? 

Savings - lock in if you don't need the money

When banks believe interest rates are going down, they cut savings rates. This has already started to happen but it’s not too late to lock in decent returns. 

Rachel Springall, finance analyst at Moneyfacts believes a fixed-rate bond is worth considering for those wanting a guaranteed return on their cash.

“The returns available on fixed rates bonds have fallen over recent months, but savers can still grab a decent return,” she said.

“The best deals today are still paying over 5%.”

It’s also important to shop around when it comes to other savings products.

“On average, easy access accounts pay just over 3%, but the best deals pay around 5%, so if someone is earning around the average rate of 3% or less, they will be losing money in real terms, as inflation stands at 3.2%,” she pointed out.

Mortgages - sit tight

The rate hikes from the Bank of England have fed through into mortgages.

This has hit people on variable rates and those looking to remortgage.

With the possibility of inflation coming down, now is probably the time to sit tight, according to Ben Yearsley, director of Fairview Investing.

“Think twice about tying into a fixed-rate mortgage today,” he said.

“Will these rates fall further when rates get cut? Quite possibly.”

However, David Hollingworth, mortgage expert at L&C Mortgages, pointed out that some fixed rates have already been priced in the prospect of base rate reductions.

“Five-year rates are currently lower and do give a longer period of security for borrowers that want to know where they stand in what is still an uncertain outlook,” he said.

According to Hollingworth, borrowers can also secure a rate before the end of their deal. It makes sense to start this process early enough to get everything in place.

“Applying for a deal will secure that rate but still leaves enough flexibility to review rates and move to a lower rate if rates do improve in the meantime,” he added.

Annuities - good time to buy

If you’re considering buying an annuity, then this could be a good time, according to Sarah Coles, head of personal finance at Hargreaves Lansdown.

“If we get the rate cuts expected, this is likely to feed through into the annuity market, so if you wait, you could get less income,” she said.

However, this doesn’t mean you should rush into it. 

“Once you have bought an annuity, you can’t unwind it, so you need to be confident it’s the right thing for you at the time,” she added.

Stock market investments - good time to buy

The FTSE 100 has already hit record highs due to the expected interest rate cuts, so this backdrop could be good for investors, according to Ben Yearsley, director of Fairview Investing.

“From an investment perspective, when rates get cut, due to falling inflation, you should see a reasonably strong positive stock market response,” he said.

Easing inflation – and the Bank of England reducing the base rate – is good news for investors, according to Jason Hollands, managing director of Bestinvest.

“Lower interest rates help companies refinance at more attractive rates and encourage more people with cash savings to invest in the financial markets for higher returns,” he said.

“I’d advocate investing in businesses with strong pricing power, rather than those highly exposed to economic factors beyond their control,” he said. “They are masters of their own destiny, have more resilient earnings and are better long-term companies to own.”

Investment funds - target the medium- to long-term

Bestinvest’s Jason Hollands also believes UK Gilts could be worth considering. 

“Currently, two-year gilts are yielding 4.37% – higher than where inflation is expected to be over the next two years – while 10-year gilts are yielding 4.26%,” he said. “A simple way to invest is through an exchange-traded fund.”

However, it’s still worth revisiting your investment decisions, according to Darius McDermott, managing director of Chelsea Financial Services.

“Consider locking into some good yields now in medium to long-term bonds,” he said. “Rate cuts would have a greater benefit for investment-grade bonds than high-yield bonds.”

He suggested the Royal London Corporate Bond Fund.

“It offers access to a portfolio of predominantly, but not exclusively, investment grade corporate bonds and has a current distribution yield of around 5.76%,” he said.