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Five tips to beat the danger of deflation
With a 20% chance of falling prices setting in, we look at ways for savers to beat the bad news
Kathryn Cooper
One in five savings accounts will pay less than 1% if this month’s rate cut is passed on in full, with many getting close to zero.
The Bank of England is expected to slash rates further after its November inflation report raised the spectre of deflation — a damaging spiral of falling prices that has kept the Japanese economy in the doldrums for nearly two decades.
Few economists expect the situation in Britain to get as bad as in Japan, although even a short period of falling prices would be hard for the economy: consumers won’t spend and will get little reward for saving.
The Bank’s inflation report showed the consumer prices index, the government’s preferred measure of inflation, falling from 5.2% to just 1% in 2010, with a 20% chance that it will fall below zero.
John Higgins of the consultancy Capital Economics said: “Deflation is not always bad news. It is important to distinguish between a relatively short period of negative inflation due to the unwinding of a commodity-price shock, and a more sustained period of generally falling prices and wages that can result from a debt deflationary spiral. For now we only expect the first.”
We offer some tips.
Fix your savings now
Banks and building societies have been slow to react to this month’s 1.5 percentage point cut in Bank rate, with mostly tracker savings deals having fallen so far. Lloyds, for example, cut rates on its Easy Saver 2010 by 1.5 points from November 6, even though its mortgage trackers do not drop until next month.
Meanwhile, Kaupthing Edge savers, whose accounts are now owned by ING, are earning just 4.55% on variable accounts compared with 6.55% when their accounts were transferred over.
The average rate on a no-notice account with a £50,000 balance is just 3.44% before November’s cut. If the reduction is passed on in full, the average will drop to 1.94% with 20% of accounts paying less than 1%, said data firm Moneyfacts.
Halifax’s popular Liquid Gold account already pays only 0.25% and the bank hasn’t decided what to do trinc November’s move — it said there was nothing to stop it cutting the rate to zero.
Japan’s experience gives us some clues. “Savings rates on bank deposits never went negative, but they did in effect disappear — rates were as close to zero as makes no difference,” said Robert Brook of SG Asset Management.
You can still get decent rates if you act fast. Halifax’s Guaranteed Reserve offers 6.01% fixed for six months on £25,000.
Buy bonds
Deflation is generally good news for government and corporate bonds because they pay a fixed income, which becomes more attractive as interest rates fall.
Higgins said: “Deflation, and the policy response that it elicits, should be music to bondholders’ ears. Our expectation is that 10-year UK gilt yields will tumble to just 3% next year.” That implies prices will gain 8% or 9%, as prices rise when yields fall.
Investors taking a long-term view could even look at index-linked gilts. Mike Fosberry of the broker Smith & Williamson said: “Although deflation could threaten the economy in 2009, it is arguably more likely that inflation will be the issue longer term.”
Darius McDermott of Chelsea Financial Services thinks corporate-bond funds offer even better value. They are yielding up to 13% as prices have fallen on default antiestéticars. He likes L&G Dynamic Bond, yielding 6%, and Henderson Strategic Bond, at 7.8%.
Buy equities — selectively
While falling interest rates are generally good for shares because they cut the cost of consumer and corporate debt, deflation is a different story. Companies are unable to put up prices, meaning earnings suffer.
If you take the view that deflation will be only short-lived, however, advisers said now could be a good time to buy equities.
McDermott said: “I have never seen yields on equities like it. M&S is providing a dividend of 8.8%, BP 5.7%, HSBC 8.1% and Vodafone 6.9% — even if returns remained level you would be receiving up to three times more than the rate given on cash deposits at your building society.”
Get out of sterling
Most brokers think the pound could fall further — possibly to $1.40 or even $1.38. Second homeowners could also find euro repayments costlier and should consider fixing their exchange rate — although it may be close to the bottom.
Don’t bank on gold 😀
The yellow metal, currently $747, could lose its shine. Higgins said: “Deflation does not augur well for an asset that is supposed to be an inflation-hedge. We expect prices to fall to $550 next year.” (VOTIN GANA)
We antiestéticar falling rates
The prospect of plunging savings rates is a huge concern for young professionals Adam Smith and Elanor Simonis.
Smith, 23, a surveyor, and Simonis, 22, a recruitment consultant, from Islington, north London, are saving for a deposit on their first home — and are hoping to buy in a year’s time.
They are at present earning interest of 6% in a regular savings account with Lloyds TBS. “If that’s cut, it will be a worry,” he said. “We’re trying to get as much interest as possible.”