With all of the talk of impending inflation, what would be the likely impact of further rises on those approaching, or in, retirement? Richard Collinson offers his verdict.

“UK households under pressure as inflation sticks at 3%” ran the headlines when the figures for January 2018 were released. The concerns were twofold: firstly, that rate is a full 1% above the Bank of England’s target; and, secondly, 3% is a bigger rise than many of the population will have seen in their pay packets over the last 12 months.

But these things are rarely black and white and inflation will affect different parts of the population very differently indeed. So, what does the threat of inflation really mean to you?

Firstly, let’s spell out what we mean by inflation. It is the percentage by which prices of goods or services increase in a year.

In the UK, the most referenced general inflation measure is the Consumer Prices Index (CPI) which includes most living costs but, crucially, excludes mortgage interest costs which are included in the Retail Prices Index (RPI).

It is the CPI that the government principally uses as a measure of inflation, and it is this index that is used to determine policy. The Bank of England has the responsibility to control inflation and has currently been set a target of 2% per annum – neither more nor less.

The most referenced method of controlling inflation is to adjust interest rates. Higher interest rates are a tool to dampen down inflation as they increase costs to consumers and therefore reduce demand, thus limiting the amount by which manufacturers and retailers can increase their prices.

Logically, therefore, lower interest rates can be used to leave more funds available for consumer spending – accordingly creating more demand for goods and giving providers more scope for increasing prices… in turn leading to higher inflation.

Phew! That’s quite enough theory

So how does that work out in real life?

For those at whom this blog is aimed, CPI is indeed the most appropriate measure, not least because for the majority of retirees, either mortgages are a thing of the past or their interest rates are fixed.

With CPI currently running at 3% per annum, there is pressure on the Bank of England to bring this down to the 2% target. The clear indication is, therefore, that interest rates are set to rise.

So, if the tactic is successful, it is, on the face of it, a good thing for pensioners: costs will rise more slowly and the hike in rates will normally not be a big concern. All things being equal…

However, for those receiving UK state pension or an index-linked company plan, increases in income will accordingly be lower. At present, the UK state pension is subject to the ‘Triple Lock’ – meaning that it rises at whichever is the highest rate: average earnings, CPI or 2.5% each year.

That’s great, but such a formula has long been widely considered unaffordable in the long term, and I suggest that it is only short term political imperatives that currently keep it alive on this basis. It became a hot topic during the last election and may well rise to the fore again next time around.

“All things being equal…” that’s the proviso that stops economists ever being right in their projections – things never are. At present, we have a volatile world in so many ways… conflicts, terrorism, trade protectionism, supply and demand for energy sources and, of course Brexit. No one knows where any of this will lead, and so whatever policy is introduced to get inflation to the ‘right’ level could be totally wrong next day.

One way in which the CPI does retirees no favours is that inflation tends to be higher for older people: the CPI does not take this into account items such as health care and care home costs which have risen disproportionately in recent years and are likely to continue to do so given that many care home groups are finding the going so tough.

Furthermore, with interest rates declining, income from savings accounts will fall and, because borrowing costs for companies will rise, there is the danger of declining profits and lower dividends and share values. This will further impact income and growth for investments and, therefore, pension plans – both now critical for those who are retired.

Now let’s get down to what it means to YOU

With all these variables to consider, how can you ever understand the real impact of all of these variables on your life in retirement?

With the RetireEasy LifePlan Classic, you can model all of these conflicting demands. And with LifePlan Premium, you can easily save and compare various sets of interest rates and inflation assumptions to see at a glance what they mean to your potential lifestyle – not just this and next year, but every year into the future.

If you want to see how, just click here…