What does the CPI rise mean for Brits?

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What does the CPI rise mean for Brits?
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With the Bank of England seeming more hawkish on inflation, another rate rise on February 3 at the next Monetary Policy Committee is on the cards – even though a rise then to 0.5 per cent would be the first back-to-back rate increases since 2004.

Even before today’s inflation data, money markets were fully pricing in one rate hike by next month and one full percentage point increase in interest rates by the end of 2022 - in other words a bank rate of 1.25 per cent by year-end.

Taking short-term views on shares is risky.

That’s not to say of course the MPC will move again in February, as they will be monitoring real economy.

The last GDP growth reading for November was strong at 0.9 per cent, but there will be uncertainty over the full economic impact of Omicron in December and January, and this could give the rate-setters pause for thought.

But with the energy price cap set to rise and add to inflationary pressures, it will be at the least a close split decision.

What does this mean for savers?

Savers with cash sitting in deposit accounts should take little comfort from the fact that the Bank of England will probably hike its benchmark rate a couple more times this year.

What’s happened since the MPC slightly unexpected hike from 0.1 per cent to 0.25 per cent on 16 December?  

Not much on the part of the big banks. 

Barclays last week became the first High Street name to react to the 0.15 percentage point rise in base rate by raising the interest on its Instant Cash Isa from 0.02-0.05 per cent to 0.05-0.10 per cent.

Its rivals are paying rates around 0.01 per cent on easy-access accounts, and two of the big banks don’t even allow non-current account holders to open easy-access savings. 

The big banks are disinterested in attracting savers’ deposits because they are already awash with cash.

They have received an influx of savings from better-off households during the pandemic as spending plunged, amounting to an estimated £187bn in deposits. And even before that they were benefitting from the Bank of England’s quantitative easing.

It’s unlikely this will change significantly any time soon – even if the MPC hikes rates further this year.

'Virtually nothing'

Although a bank rate of 1.25 per cent would notionally be the highest for 13 years, it means virtually nothing to savers: the UK’s leading retail banks don’t need savers’ deposits and so will probably decline to pass on base rate hikes in any meaningful way.

And even if they did, interest is more than eclipsed by inflation, leaving real returns on cash savings deeply in the red. When will real interest rates on savings reach zero, and inflation cease to eat into the value of cash deposits?  

When savings rates are at 2 per cent and inflation at 2 per cent? That is not an equation that is going to happen for a long time.

One crumb of comfort however, is that a bank rate of 0.5 per cent is likely to prompt the MPC to start unwinding QE and that means some of the downward pressure on savings rates could start to lift.

What about bank shares?

What has happened to the big retail banks’ share prices since 16 December. As of today (January 19):

  • Barclays: 19.2%
  • Lloyds Banking Group: 23.4%
  • Natwest (RBS): 15.8%
  • Metro Bank: 26.4%

In comparison, the wider UK stock market has risen by approximately 3.3 per cent over the same period. 

Rising interest rates are generally good news for retail banks as it means they can grow the margin between what they earn from loans and what they pay on deposits.  

This is achieved by raising mortgage rates faster than savings rates in response to Bank of England rate rises – and that’s what we’ve seen since December 16.

In contrast to the lethargy on savings rates, Santander, Lloyds and Halifax all announced increases to their standard variable mortgage rates by the full 0.15 per cent shortly after the Bank of England’s decision on December 16.

It would be fatuous to say savers would have done rather better to use their savings to buy bank shares on 16 December - taking short term views on shares is risky. But the comparison reveals a kernel of truth.

The UK stock market is quite financials-heavy – with about 17 per cent of the blue-chip index made up by banks and insurers – so British investors don’t have to look too far for an index fund or more active funds that have high exposure to the sector.  

Adrian Lowery is personal finance expert at investing platform Bestinvest