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High inflation - and it could keep rising
By Rob Griffin
Inflation is back in the news after soaring to an 11-year high of 3% - and while the most optimistic point to the possibility of falling energy costs in 2007, the pessimists highlight rising consumer prices and increasing wage demands.
The debate has been triggered by the publication of official figures showing that the government-targeted level of inflation - the Consumer Price Index - rose to 3% in December, up from 2.7% the previous month.
Mervyn King, the governor of the Bank of England, has blamed the rise on the historically low level of interest rates. The rapid growth of money and credit have contributed to rising asset prices and buoyant nominal spending, and, as a consequence inflation expectations have risen and firms have been able to raise prices a little faster than before.
Also, increasing cost pressures have made it more difficult to sustain profit margins without raising prices.
Energy prices
"Energy and import prices are one source of higher costs," he said. "Another is the cost of employing labour which has been rising faster than the growth of real take-home pay. Higher pension costs for companies, on the one hand, and higher taxes, petrol and utility prices for employees, on the other, have opened up a gap between increases in the pay bill and real take-home pay."
Unsurprisingly, the figures have whipped up a political storm. Conservative shadow chancellor George Osborne has already gone on the attack by claiming rising living costs were already taking their toll on working families - and any future interest rate hikes would only increase the burden.
Official inflation in Britain is double that of the rest of the world, Osborne said, and double the level it was when Gordon Brown took office in 1997. "Britain is now suffering from the triple blow of rising inflation, rising interest rates and rising unemployment."
But Tony Blair is adamant that the economic foundations are sound, and has insisted that inflation is artificially high due to high oil prices and will soon be on its way down.
There is certainly evidence to support this assumption. The price of a barrel of oil has fallen substantially in recent months while an industry report says consumers can look forward to the prospect of falling energy bills soon, as wholesale gas and electricity costs have fallen by 55% and 42%, respectively.
British Gas has announced it would cut gas bills by 17% and electricity by 11%. See British Gas To Cut Residential Prices
The level of pay rises, however, will be a deciding factor. A recent survey by Incomes Data Services found annual wage settlements were averaging 3.5% in the three months to January - a six year-high. If companies are paying higher wages this could have an impact on inflation figures, but this won't become clear for a few months yet.
So how does rising inflation affect different groups?
Savers
Savers don't fare well when inflation is rising, as it erodes their capital and income in real terms. They need to examine the pros and cons of investment products if they want to combat inflation.
Certain investment products guarantee that your interest will beat inflation tax-free. This makes them very attractive to taxpayers. The downside is that your capital stands still, so will be eroded by inflation.
Homeowners
Inflation is a double-edged sword for homeowners. If it rises - and your wages go up, while interest rates remain the same - then that puts you in a better financial position to pay the mortgage. However, inflation will mean household bills also go up, which is likely to wipe out any gains you make on your mortgage repayments.
The elderly
The over-75s are still the ones being hardest hit. The inflation rate of the elderly increased to 4.2% in December 2006 - more than double the Government's target.
The impact of higher prices for basic goods, such as gas, electricity and food, falls most heavily on the elderly, who spend a larger proportion of their budgets on these necessities.
Benefit from inflation
Inflation doesn't automatically mean misery for everyone. For example, recent months have seen the prices of clothing and footwear falling due to widespread special offers.
Those who have an inflation-linked increase in benefits or pay, for example, also won't be suffering financially.
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