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You need to work out your personal inflation rate

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I am about to suffer a painful personal encounter with inflation: from late November my electricity and gas bill will go up by about 25 per cent.

My low-cost fixed-price tariff will expire at a particularly unfortunate time to be replaced by my energy company’s variable rates — or an exorbitant new fixed-cost tariff.

Of course, millions of us are in the same position, though not everybody lives in a draughty Edwardian house with rattling windows and doors. My fault, I know, for being seduced by the charms of a period home and for living in a country with the world’s oldest housing stock.

But it certainly made me think about price increases. With inflation up sharply since the summer to 3.1 per cent in September and expected by the Bank of England to increase further, to 5 per cent next year, we can all expect the prices we pay for goods and services to rise.

That’s a worry, as we have become used to much lower rates in recent years. Moreover, as our energy bills show, the increases don’t come in steady increments but in unpleasant, unpredictable jumps.

Also, inflation doesn’t hit us all equally. The Office for National Statistics, the government’s statistics agency, bases its consumer price index on a basket of about 720 goods and services, weighted according to the buying habits of the average household.

But all of us have different preferences and constraints, not least our earnings. Typically, poorer people spend a much higher share of their income on food and other basics, while the well-off can choose to go out, travel and change their cars frequently.

While inflation was low, the differences in the inflation rates of different social groups did not diverge greatly, though poorer households bore the brunt of sharp increases in energy prices in the decade to 2015.

But now that overall inflation is picking up, we can expect big bumps in individual prices that will hit people unevenly. For instance, the ONS figures for the year to September show that stuff purchased by the better-off has gone up more than the average, as rising petrol prices drove up the cost of transport and carmakers jacked up prices.

On ONS data, prices rose 3.7 per cent in the year to September 2021 for the highest-earning tenth of households compared to 2.8 per cent for the poorest 10 per cent.

This trend may continue for months, if not longer, if current wage increases in hard-pressed sectors such as haulage convert into broader increases in labour costs. The government is encouraging employers to pay more at the bottom end, not least in social care. And quite rightly — employment pay growth for almost all except the top income tiers has been depressed for over a decade, as the independent Office for Budget Responsibility pointed out in its Budget report.

So it is high time for us to get a stronger grip on our own inflation outlook. In some enlightened territories, including Canada and the eurozone, the authorities offer websites which help people calculate a personal inflation rate by inputting their own spending information.

In the UK, there is nothing like this, though the ONS publishes the relevant data. Instead, according to Google, we have a BBC website calculator (that now doesn’t work) and, seemingly, just one other, produced by Rathbones, the wealth adviser. A poor show in a country which prides itself on its financial services industry.

Even seemingly small differences in inflation rates accumulate over time through compounding. I worked out my own inflation rate, using the Rathbones calculator, as 3.7 per cent, so 0.6 percentage points above the average. Over 10 years, that translates into a 44 per cent increase in my household price basket, compared to 36 per cent for the average.

And that is at current inflation rates — if the average went to 5 per cent next year and then stayed there, the decade-long rise would be 63 per cent. Who would like to estimate how much social care costs might increase in this context, given current wage pressure, chronic staff shortages in the sector, immigration controls and an ageing population?

No surprise then that in a Opinium poll published this week by Fidelity, the investment house, the cost of living (75 per cent) and inflation (53 per cent) topped the list of respondents’ post-Budget concerns. Way above Covid on 36 per cent.

Ian Browne, a retirement expert at Quilter, a wealth adviser, says: “Working out the inflation pressures on your finances is a cornerstone of financial planning.” It’s not just a matter of calculating how much your current budget might be squeezed but also looking out for chunky future expenses — redecorating the house for example.

Nor is spending the whole story. Inflation affects our income too. Big employers’ pay awards generally reflect inflation, but there’s no law that says they must. Wage rises ultimately have to be driven by productivity increases. So if you are in a low-margin low-productivity sector it’s a good time to think about switching jobs, especially as companies are currently reporting lots of vacancies.

Meanwhile, state pensions are still protected by the triple lock under which they are to rise annually by the highest of the inflation rate, average earnings increases and 2.5 per cent. Next year’s likely pause raises doubts about the promise’s sanctity but, given the pensioners’ weight in the voting population, the arrangement looks more secure than many future income pledges.

Members of defined benefit schemes — current and future pensioners — can also normally trust their funds’ inflation links, barring huge financial shocks. But those with defined contribution arrangements face uncertainty. It’s important to consider whether the fund is properly positioned for inflation: broadly that the traditional bonds/equities balance is firmly weighted towards equities, which tend to fare better in inflationary times than fixed-income.

Few people nowadays take out fixed-income annuities, which are not usually inflation-protected. But older pensioners with such investments need to watch out as income, in real terms, would be squeezed if inflation persists.

A much bigger pot for many savers is cash, especially as better-off householders have seen bank balances rise under the pandemic, for lack of travel opportunities on travel and so on. Even though the Bank of England held firm yesterday, keeping the base rate at 0.1 per cent, market interest rates are creeping up — which should be good for depositors.

But beware, what matters is the real — post-inflation — rate of return. Last year, when inflation averaged 0.8 per cent, getting 1 per cent on a term deposit meant a small real return of 0.2 per cent. If, next year, inflation hits 5 per cent, it would need deposit rates of 5.2 per cent to make the same money. Highly unlikely. So the incentive to look again at diversifying, perhaps boosting equity holdings, will increase.

None of this is about taking fright at inflation. Nobody predicts a rerun of the runaway inflation of the 1970s. But the low-inflation environment of the past decade seems to be over, and it’s a good time to take stock.

Stefan Wagstyl is editor of FT Money and FT Wealth. Email: stefan.wagstyl@ft.com. Twitter: @stefanwagstyl

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