Inflation slows for sixth successive month: what it means for your money

Few things are more damaging to an economy than soaring inflation. So the news that the consumer price index (CPI) has slowed to its lowest level for more than a year is warmly welcome. 

In December, year-on-year inflation dropped back to 6.5 per cent from 7.1 per cent the month before, the sixth consecutive month of declines. 

While inflation remains significantly higher than the U.S Federal Reserve’s (Fed) target of 2 per cent, its current trajectory indicates that the cost of living pressures are gradually assuaging.  

The biggest factor last month was gas prices, which dropped 9.4 per cent between December and November. This reduction offset the shelter index – a measure of the costs associated with housing, mainly rents - which increased from 0.6 per cent to 0.8 per cent.

What’s going on with interest rates?

Though there are signs the cost of living crisis is easing, interest rates continue to go up. 

The US central bank had its hands full during 2022, raising rates at their fastest pace for several decades in a bid to tame surging inflation, which hit 40-year highs. 

The most recent rate raise came in December in the monetary policy committee’s final meeting of 2022. The half a percentage point hike took rates to a targeted range of 4.50 per cent and 4.75 per cent, shoving borrowing costs to their highest level since 2007, the year before the global financial crisis. 

This move followed four consecutive 0.75 percentage increases in June, July, September, and November. 

How the rate rises are affecting you depends on your personal situation. To briefly summarise, when rates go up, borrowing money becomes more expensive but you can earn more on your savings. When rates go down, the opposite occurs. 

What’s the outlook for inflation?

As noted above, inflation coming down is encouraging news, and a swift departure from the eye-watering figures we saw last year. 

However, it’s worth remembering that inflation is still three times higher than the Fed’s target. The cost of things like your weekly shop are continuing to rise, just at a slower pace than they were six months’ ago. 

Last month, US Treasury Secretary, Janet Yellen, said she expects inflation to be much lower by the end of the year. That said, due to the looming threat of recession, the consensus is that CPI will remain above 3 per cent. 

For this reason, we would expect interest rates to rise again on 1 February when the MPC holds its first meeting of 2023. Experts are torn whether the Fed will opt for a lighter hike of 0.25 percentage points, or repeat December’s rise of 0.50 percentage points. 

Much will depend on the economic data released between now and then. If the outlook for inflation is better than expected, then the Fed may well opt for a more conservative approach. 

In December, the Fed indicated that it expects rates to peak somewhere between 4.75 per cent and 5.75 per cent in 2023. So, while further increases are expected, the trajectory is set to be less aggressive than what we saw in 2022. 

How is inflation affecting my savings?

High inflation is typically bad news for any money you have in savings. Currently, the average savings account has an annual percentage yield (APY) of just 0.22 per cent. 

However, the Fed’s series of rate rises is boosting what banks will pay you for your money. The top savings accounts are currently offering somewhere between 4 and 4.35 per cent, meaning the gap between savings rates and inflation has narrowed dramatically over the past 12 months. 

But with inflation at 6.5 per cent, even if you secured the best rate in the market, the real value of this money is being eroded. 

While a bit of inflation is generally seen as a good thing, if price rises outstrip the money you earn on your hard-earned savings over a prolonged period, this could negatively impact your future financial goals.

Currently, the average savings account has an annual percentage yield (APY) of just 0.22 per cent

What investments can beat inflation?

With prices likely to be high for some time yet, regardless of what action the Fed takes with interest rates, it’s important to consider investments that offer the potential of beating inflation. 

If you have no plans for the money for a period of five years or more, then investing in the stock market can offer an excellent hedge against rising prices. We must sound a note of caution, though. When investing in equities the value can fall as well as rise, so you must be comfortable with this aspect. 

However, by spreading your investments across lots of companies, involved in various industries all around the globe, you can reduce the amount of risk you take. If you’re unsure about what level of risk you’re comfortable with, seeing a qualified financial advisor will help you make the right choices. 

Another option is to invest in gold, which is often deemed a ‘safe haven’ for investors. But like stocks the metal can be subject to sharp swings in value. We saw evidence of this recently. In October 2022, the price of gold fell to $1,626 an ounce, but by January it had rebounded to $1,920. 

Treasury bonds are a further consideration and considered lower risk than those outlined above because they are backed by the government. They come in two main types – series I savings bonds and treasury inflation-protected securities (TIPS) – and both are designed to protect you from inflation. Another similarity is that they adjust interest rates based on inflation. 

With so much uncertainty around, we appreciate that finding the right home for your savings and investments is difficult right now.  

If you’re stuck, there is no better time to speak with an investment expert, who will take the time to understand your financial goals, and put in place a suitable strategy to help you achieve them.