This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here.
The economic clouds have darkened further for two reasons. One, which affects just about the whole world, is the deteriorating outlook for inflation as a consequence of hostilities in the Middle East continuing through into the summer. The other is domestic, for the inevitable uncertainties over the UK’s financial management have pushed up the cost of borrowing not only for the government, but for anyone seeking to get long-term finance.
As far as inflation is concerned, one signal of alarm came from the US, where the annual inflation rate jumped in April to 3.8 per cent, the highest since May 2023, as a result of higher energy prices. We will not get UK April numbers until next week, but looking further forward, the most optimistic forecast of the Bank of England suggests inflation will peak at around 3.6 per cent by the end of this year, while its most pessimistic figure is 6.2 per cent early in 2027.
The effect of all this is that the chances of any interest rate cuts this year from the Bank of England are vanishingly small. Indeed the markets are predicting that the next movement will be up, not down. In addition, it is hard to see any significant decline in longer-term rates until our current political situation clarifies. The yield on 10-year government bonds, gilts, remains over 5 per cent – the highest since 2007 – while the yield on 30-year gilts at around 5.75 per cent is the highest since 1998.
The danger is that any successor to Sir Keir Starmer would face a crisis of confidence among international investors, and as a result the UK would have to pay even higher costs to fund the national debt than it does at the moment. Indeed, when it became clear on Wednesday that the Prime Minister and Chancellor would remain in post a little longer, gilt yields actually declined slightly. The concern is that whoever replaces the present team will be even less disciplined in keeping government borrowing under control.
The rest of us have to live with the judgements of the markets, whether we like them or not. The only safe assumption, therefore, is that for the rest of this year and probably beyond, both inflation and interest rates will be higher – maybe substantially higher – than they are now.
Having the central banks put up interest rates does not make the price of oil any cheaper, or curb the inevitable consequences of what has already happened as a result of the closure of the Strait of Hormuz. But it is the only weapon they have of stopping the increase in energy costs becoming embedded in the wider economy and pushing up prices that are not directly affected by this.
So, what should we do?
The starting point is that we have to accept there may be a financial crisis of some sort. Let’s hope there won’t – and I certainly don’t think it is inevitable – but it would be naïve not to acknowledge that there is a risk. You don’t want to be refinancing a mortgage in the middle of a crisis, so we should try to make ourselves financially bullet-proof.
Everyone’s circumstances are different, so it is impossible to do more than sketch some principles, but here are some of them:
First, people should secure borrowings. Better to pay a little more now and be certain than take a risk on getting a cheaper rate in a couple of years’ time. It is quite possible that the fears noted here will ease, inflation will be beaten back and that economic growth will resume. But we cannot assume that will happen.
Next, there may be a sharp, though temporary, fall in property prices. What has happened in central London may be replicated elsewhere. In the long-term, the UK housing market will be fine, but you don’t want to be a forced seller at a bad moment in the market.
If interest rates are heading higher, it makes sense to clear the most expensive debts – notably those on credit cards. Since the return on savings is almost always lower than what we pay for debt, people use spare cash to cut borrowings.
It also makes sense to maximise the interest we are paid, naturally on an ISA where possible, as otherwise we are being taxed on the interest even if that interest is simply compensating for inflation.
However, on a longer view it always makes sense to save with an equity ISA rather than a cash one. There could now be as many as 17,600 equity millionaires, according to Rathbones, the wealth managers. It is hard to be absolutely certain but it is most unlikely there are any cash ISA millionaires at all.
Finally, there are lots of small general points where attention of detail can have a cumulative impact on personal finances. For example, at times of financial pressure, companies have to offer deals to drum up business. That is an opportunity for would-be customers to shop around. However, many service contracts have inflation clauses written in, linking future charges to the consumer price index – or worse, the retail price index, which is higher than the CPI. Beware of those.
None of this is easy, because it means paying attention to something that many people find boring. But coping with tougher times requires discipline, and I am afraid times will indeed become tougher in the months ahead.
Need to know
Inflation is such an insidious thing that we tend to forget how relentlessly it wears away the real value of our savings. For anyone feeling they need an anchor, I suggest they go to the Bank of England’s Inflation Calculator here, and see what has happened over really any period, but particularly the past few years.
The data goes back to 1209, yes that is correct, so you can have lots of fun seeing what a craftsman in the 13th Century could buy with their annual wage of £5. That would be equivalent to around £9,000 today, so a long way below our national living wage today of around £26,437 for a 40 hour week. But not that much less than the full state pension which despite the triple-lock works out at only £12,548 a year. And a chicken, by the way cost 0.5 old (i.e. pre-decimal) pence, which on my quick tally, works out at about a fiver in today’s money – and wasn’t a tasteless broiler either.
The greatest inflation – not just in living memory, but ever in our history – was in the 1970s and 1980s. A typical starting salary for a graduate in 1967 of £1,200 (to pick the year when I came to London and got a job as a journalist) would be £19,484, so well below the national living wage now and not much better than the farm labourer of 1209. What’s more, I was very glad to get the job.
But look at what has happened since Tony Blair came to power in 1997: if you took £10,000 as a salary then, you would need £21,087, now. The average inflation since 1997 was 2.42 per cent. So even this relatively low inflation rate, which is not that much above the Bank of England target of 2 per cent and way below the present level, still means that inflation doubles over less than 30 years. I find that pretty chilling.