The rate of inflation is declining. What now? 

12 December 2023

At the end of 2022, the rate of inflation in the UK was in double figures.

Indeed, the Office for National Statistics (ONS) reports that last December, inflation stood at 10.5%, after peaking at 11.1% in October 2022. Now, as of October 2023, the rate has more than halved, sitting at 4.6%. 

This is welcome news. Last year’s 40-year high in inflation contributed to the UK’s cost of living crisis, and placed many people’s finances under strain.

As we head into a new year, you could be wondering whether inflation will continue to decline, or if it’ll remain “sticky” at its current rate. 

While there’s no telling exactly what will occur in the future, keep reading to find out our take on why inflation has declined, what could happen next, and what any future changes could mean for your wealth.

The Bank of England has played a major part in reducing the rate of UK inflation

In response to the rising tide of inflation that occurred after pandemic lockdowns eased, the Bank of England (BoE) began to hike the base interest rate. The BoE has an annual target inflation rate of 2%.

After lowering the base rate to just 0.1% in March 2020, in response to Covid-19, the BoE has now hiked the rate 14 times, bringing it to 5.25%, where it has been fixed since August 2023. Most lenders have taken on this rise too – Moneyfacts reports that as of 14 December 2023, the lowest five-year fixed-rate mortgage loan was available at 4.57%.

In theory, raising interest rates curbs inflation by reducing consumers’ disposable income. Once the public spends less, prices generally come down, which is often reflected by the rate of inflation.

Although raising interest rates can help to control inflation, this can affect the cost of living too

It’s important to recognise that inflation and interest rates are very strongly linked – and while inflation is coming down, this is only one small part of the bigger picture.

As far as your outgoings are concerned, higher-for-longer interest rates could make repaying your debts more expensive over the long term. On the other hand, lower inflation could mean daily life becomes cheaper again. This is a challenging balance to strike for the BoE.

Indeed, to understand just how impactful the BoE’s recent hikes have been, it’s important to look back to 2007. 

Between December 2007 and February 2009, the base rate was reduced from 5.5% to 1%. These decreases were implemented in the wake of the financial crisis. Then, between February 2009 and May 2022, the base rate remained below 1%.

So, while the recent interest rate increases have helped to control inflation very effectively, a 5.25% base rate seems very high compared to the past 15 years. 

As such, these base rate increases are contributing to the UK’s cost of living crisis. And, if inflation remains sticky at around 4%, the BoE could continue to push the base rate up in response.

In more positive news, if the rate of inflation keeps falling, the BoE may reduce the base rate again, although it is unlikely that the rate will drop below 1% for some time.

Once again, inflation is only one factor contributing to the rising cost of living – so while its decline is happy news indeed, it is important to remain aware of the other elements affecting your wealth. 

While the overall rate of inflation has decreased, some costs have fallen more than others

A major contributing factor towards the decline in UK inflation has been falling energy prices.

According to a Guardian report, “At the heart of October’s decline in inflation was the 23% year-on-year cut in the energy price cap for the typical annual gas and electricity bill, from £2,500 last October to £1,923 the same month this year.”

Importantly, other sectors are still experiencing high inflation. Statista reveals that food and drink inflation was 10.5% in October 2023, down from its 19.1% peak in March.

With this in mind, it is essential to remember that while a fall in inflation is a positive sign, day-to-day costs may still remain higher than the overall inflation rate indicates. 

For a more granular breakdown, it could be helpful to look at your “personal” inflation rate, based on the goods and services you pay for regularly, rather than the overall figure.

A lower inflation rate could have a positive impact on your money

Over the long term, a return to an inflation rate that remains around the BoE’s target of 2% could have a positive impact on your wealth.

Firstly, rising prices can have an effect on the stock market – investors can become spooked, and corporate profit margins can fall too, often leading to share prices dipping. While there have been several factors affecting market volatility in the past three years, inflation has likely been one of them.

Fortunately, a decrease in the rate of inflation could have the opposite effect, and may contribute to market stabilisation in 2024.

What’s more, even though food inflation remains high, it’s clear that many costs are coming down, which can only be good news for your monthly and annual budgets. 

As such, while there are still many cost of living factors to be aware of in the coming year, declining inflation may indicate easier times ahead for many families.

Get in touch to learn how financial planning can help you respond to inflation

Working with a financial planner can help you adapt to the economic conditions that are beyond your control. 

For guidance on making the most of your wealth no matter the circumstances, email or call 0161 8080200.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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