United Kingdom

HAMISH MCRAE: Back to basics to tame inflation

Don't say you weren't warned. Inflation is back. Last month, the consumer prices index was up 3.2 per cent and the retail price index up 4.8 per cent. 

They will go higher. The Bank of England forecast that the CPI would reach 4 per cent this autumn, and I could see the RPI hitting 6 per cent. And this is happening at a time when we are pushed to get even 0.5 per cent interest on a bank account. 

There is no point in fulminating against the Bank of England, for it has to follow the global mood in central banking. This is that the surge in inflation will subside as some sort of normality returns, and that meanwhile it is more important to keep the money flowing and interest rates nailed to the floor. 

Upward trend: The world's central banks may have made a huge collective mistake in stoking up inflation

There has, however, been a small shift in the wind in the past few days. Goldman Sachs has warned that rates might go up faster than the market thinks, with the first increase in Bank base rate coming next May. That is more than a year earlier than it had previously projected. The Treasury is getting seriously worried, as it should be, about the rising costs of funding the national debt. So it will announce some new rules for controlling the deficit, with the aim being to convince the markets that it really will be fiscally responsible in the future. 

As for the Bank of England's intentions, we may learn more from the Monetary Policy Committee meeting this Thursday, but whatever they do the harsh reality is that interest rates will be lower than inflation for the foreseeable future. 

It is called financial repression – holding interest rates below inflation – and it was the way the Government reduced the burden of the national debt after the Second World War, getting it down from more than 250 per cent of GDP in 1945 to 30 per cent by 1990. It is now a whisker below 100 per cent. 

So what should we do? 

Well, the first thing to do is not to make the mistakes that savers made in the 1950s and 1960s by holding Government stock. On Friday 10-year gilts were yielding 0.8 per cent. That is absurd. 

No sane person would buy that debt when it will give a guaranteed real loss over the next decade. So in practice most of the debt is held either by the Bank of England itself, which 'owns' more than 35 per cent of the national debt, or by other financial institutions that are compelled by regulations to hold gilts. 

But saying what not to do is easier than saying what you should do. In the 1950s it was clearer. You switched out of gilts into equities – the 'cult of the equity' was a movement pioneered by the legendary pension fund manager George Ross Goobey, who saw that the shares of solid companies were actually safer than supposedly safe government debt. Now it is tough. 

It is particularly tough because all that money printed by the central banks has to go somewhere, creating a summer of froth where every fashionable investment opportunity draws in the dosh – and pushed the price of those assets to absurd levels.

 The investment organisations with the biggest pots get there first, which does not leave so much for ordinary savers. For anyone with savings, however, the basic rules apply. People should have a cash buffer so they don't have to sell assets at the wrong time. 

They should spread risk both in the types of investment and their geographic spread. Having some shares in the high-tech American giants has saved many British investors over the past couple of years. Everyone should use what ever tax incentives are available. If an employer will match a pension contribution, it is a no-brainer to take the money. Rely on compound interest to build wealth. And so on – the wide range of personal finance advice in this paper is a good place to start. 

Protecting ourselves against inflation is not simply about investing our savings. It is also about making ourselves bulletproof in other ways. It is about making sure we have a secure flow of income. It is about making sure we have a roof over our heads. Property may not be as great an asset over the next decade as it was in the past, but we all need somewhere to live.

To end on a positive note, remember this. The world's central banks may have made a huge collective mistake in stoking up inflation. But they don't want a financial crash. They don't want mass unemployment. So they will do their utmost to keep the world economy growing – and that gives us time to sort ourselves out.

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