Shop smart to beat the soaring cost of inflation

Published on Saturday 17 May 2008 14:32

THE worries of millions of families about the increased cost of living were officially confirmed last week as the Office for National Statistics revealed that the annual inflation rate has surged to 3%, the steepest increase in almost six years.

But there is worse to come. Governor of the Bank of England Mervyn King last week warned that inflation was about to take off sharply and would soon reach 3.7%, far in excess of many families' annual increase in their income, squeezing household budgets further.

Officials blamed rising food prices for the hike in the Consumer Prices Index (CPI), the Government's preferred measure of inflation. But many prices are rising much faster: a separate survey by the shopping website mySupermarket found a typical basket of groceries is now 19.1% higher than a year ago.

Johnny Stern, a director of the website, said: "We are seeing large increases in the price of the average family's basket, with wheat and dairy-based products going up as much as 61%."

Higher food costs are not the only concern: mortgages, utilities and petrol are all on the up. Gas and electricity bills have risen 15% on average this year already, with Scottish Gas hinting strongly last week that more rises will soon be necessary.

In the case of mortgages, the latest inflation figures make it less likely that the Bank of England will cut interest rates and help reduce monthly home loan payments. Raising the cost of borrowing is a key tool in the fight against inflation

As Simon Ward, chief economist at New Star fund managers, pointed out: "A nonchalant Monetary Policy Committee response to a significant and prolonged (inflation] overshoot risks undermining its credibility. The view that the MPC should continue to cut interest rates because a weakening economy will ensure inflation is back below target in two years' time is questionable, to say the least."

There is no doubt a bigger chunk of our incomes is disappearing on the basics. But how do we best measure these price increases?

There are currently two main ways that inflation is measured in the UK. These include the Government's preferred option, the CPI; and what is known as the Retail Prices Index, or RPI.

The Government has set itself the target of keeping inflation at 2%. However, it's currently running at 3%. The RPI, on the other hand, is at 4.2%. Both of these measures work by tracking the prices of a selected basket of goods and services.

They differ in terms of exactly what goes into those baskets of goods and services, and the two are also based on different underlying assumptions. One major difference is the RPI reflects housing costs, such as house prices and mortgage interest costs, while the CPI does not.

"The result of those two differences, in ordinary circumstances, is that CPI inflation is normally about 0.75% lower than the RPI," said Jonathan Loynes, chief UK economist at independent research consultancy Capital Economics. He believes suspicions that the CPI dramatically understates inflation are "overdone" and consumers simply notice price hikes more than they notice the price decreases.

Meanwhile, Louise Cuming, of price comparison site moneysupermarket.com, suggests that RPI is a more "realistic" measure of inflation for homeowners because it includes housing costs. For the likes of pensioners, however, who are less likely to have a mortgage, the CPI is more applicable, she says.

But everyone differs in what they spend their money on and therefore how they are affected by price inflation. As a result, the Office for National Statistics offers an online personal inflation calculator that allows you to input your own spending patterns to give you a more individualised idea of how inflation affects you.

So how is it possible to beat inflation while still keeping up your standard of living? Steve Shore, a director of Abbey Banking, recommends always shopping around, as well as being thrifty the next time you go to a supermarket, and avoid buying more than you need. "It is often difficult to estimate food consumption, but saving an extra few pounds on the weekly shop can go a long way, especially when people are already feeling stretched."

He recommends stashing any money saved into a high-interest account. Yet experts point out that inflation can lead savings ratios to fall because the gap between what we earn and what we spend means we have less money to put away.

Ironically, there has never been a better time to save, especially in products that match RPI. For example, National Savings & Investments offers a choice of two tax-free Index-Linked Savings Certificates which promise to match RPI plus 0.35% in the case of five-year plans, and RPI plus 0.25% for three-year ones. Up to 15,000 can be invested in each issue.

RPI is currently 4.2%, so the certificate pays the equivalent of 4.55% tax-free. To get the same net rate of interest in another savings account, a higher-rate taxpayer would need to earn about 6.35% gross over five years, while a lower-rate taxpayer would be looking for about 5.5% gross.

But they are not so good for non-taxpayers, who can earn higher rates of interest and pay no tax, up to their annual allowance, by filling in an R85 tax form from their bank or building society.

Bargain hunt

Reduce your food bills – mySupermarket.co.uk claims it can take 20% off your food bill by scanning the four main chains to find the cheapest options. It says few of us need to travel more than three or four miles out of our way to find the lowest prices.

&#149 Cut your energy costs – You could save up to 325 a year by getting on the cheapest energy tariff. There is a complete list of comparisons at www.energy watch.org.uk. Or move to a cheaper tariff with your existing supplier.

&#149 Mitigate your mortgage bill – If your mortgage deal has come to an end, don't sit around on your lender's standard variable rate. Talk to a mortgage adviser about finding a cheaper offer.

&#149 Cut petrol costs – The difference between the most expensive and the cheapest station in your area can be up to 20p a litre. Find out more at www.petrolprices.com. Or use alternative transport.

&#149 Move motor and home insurance to a cheaper supplier – We often squander hundreds of pounds a year by not comparing quotes every year. One of the sites that can help is moneysupermarket.com.

&#149 Be a more effective shopper – The price difference between the exactly the same products can run to hundreds of pounds. Use a comparison service from.pricerunner.co.uk.

&#149 Savings, mortgages, current accounts, credit cards – Paying unnecessary interest or not getting decent returns on hard-earned savings is silly. Comparison sites such as Moneysupermarket.com, uSwitch and MoneyExpert will give you the best deals.