Need to Know: How will higher UK inflation affect your assets?

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Wednesday’s UK inflation report came as a shock to economists, politicians and consumers who had anticipated the rate of price increases would continue to tick down.

December’s inflation rate came in at 4 per cent, 10 basis points higher than the previous month, 20bp above expectations and double the Bank of England’s inflation target. The jump was caused largely by increases in alcohol and tobacco prices.

The news tempered hopes that the BoE would cut interest rates in the near future. The market-implied likelihood of the first rate cut occurring in May fell to 55 per cent from 80 per cent.

FT Money explores what the inflation reversal could mean for investments, mortgages and pensions.

Will mortgage rates rise again?

In recent weeks, mortgage providers such as Barclays, Santander, HSBC and Halifax cut rates in the wake of positive data about the UK economy, an increase in house sales and expectations that interest rates had peaked.

While experts say that in the long term mortgages are still likely to come down, Wednesday’s inflation news will give pause to providers offering increasingly generous rates.

“We had a lot of good news in recent months, helped by falls in inflation,” said David Hollingworth, associate director at broker L&C Mortgages. “This [reading] could potentially push the timeline for base rate cuts further away, and it underlines that it is not the case that fixed mortgage rates will keep coming down and down and down.”

In response to Wednesday’s inflation announcement, so-called swap rates — which influence lenders’ pricing of their fixed-rate mortgages — rose by over 20 basis points for two-year and five-year deals.

As of Friday, average two-year and five-year fixed mortgage rates were 5.61 per cent and 5.24 per cent respectively, according to finance website Moneyfacts, unchanged from the previous day.

Ray Boulger, an analyst at broker John Charcol, said that since the inflation rate was “clearly going to have a negative influence”, mortgage hunters should take good deals while they are on the table.

“For anyone buying and securing a mortgage: don’t expect the best rates to fall from where they are now,” he said. “There’s no harm in talking to a broker and securing a rate in the knowledge that if rates fall further you can try to switch.”

Will inflation eat into my savings and investments?

Cash had appeal in 2023 due to climbing interest rates, but savings rates have started to fall in anticipation of the BoE making cuts.

Although Wednesday’s inflation reading runs against that trend, experts do not expect cash rates to reverse their decline.

“I think that banks and building societies are going to sit still for a bit,” said Daniel Coatsworth, an investment analyst, at AJ Bell. “From the initial shock you might expect better [cash] rates but I don’t think it’s enough to warrant a radical shift.”

The news may also be unwelcome for investors concerned about their equity portfolios. The FTSE 100 closed down 1.48 per cent on Wednesday, as questions about the pace of interest rate cuts swirled.

“We definitely saw a reaction, particularly among highly leveraged firms,” said Hargreaves Lansdown’s head of personal finance Sarah Coles. “But after the initial reaction we would expect that to level out . . . markets hate surprises which is why we saw a bit of a fall, but we’re not expecting a dramatic reaction on an ongoing basis.”

What will higher inflation mean for my pension?

Although fluctuations in the stock market caused by the inflation readings will affect the value of pensions, experts warned that Wednesday’s rate should not be cause for panic.

“Pensions are long term investments if you’re young, but even if you’re going into drawdown you could well be invested for another 10, 20 or 30 years,” said James Norton, a senior investment planner for Vanguard UK. “So we would urge people to not read too much into one month’s numbers.”

However, if inflation were to continue climbing, the purchasing power of pensions would decrease. Clashes in the key shipping lane of the Red Sea could also cause product shortages and drive up prices.

“When the stock market is not seeing smooth growth at the same time as higher inflation, you see people’s retirement position start to worsen,” said Coles.

For pensioners with certain types of defined benefit schemes, inflation rates can affect the monthly payment.

While many schemes increase in line with prices, some are capped at between 3 to 6 per cent, meaning that if inflation runs higher pensioners’ pockets will be hit.

However schemes can issue discretionary payments to help their members weather harsh economic conditions.

“Lots of trustees have been thinking about whether to give discretionary increases,” said David Brooks, head of policy at Broadstone, a pensions administration and consulting firm. “But although inflation has gone up, it’s trending downwards which might bring those conversations to an end.”