UK Deflation

Nostalgia isn’t what it used to be

We received a letter from a client this week. Nothing strange in that you might say, but “eagle-eyed Melissa” noticed that it had several stamps on it and one of them was a 5.5p stamp. Being married to a postman she notices these things and chuckled. She had not seen anything with an halfpenny on it for a while and a quick Google search confirmed the client must have had this stamp at the back of his drawer since at least 1975!

Now in 1975 5.5p was enough to send a second class letter. Today it’s 54p. Just 40 years later on the price is 10 times higher almost.

Deflation – That’s bad isn’t it?

Beautifully by coincidence, this week we hear inflation has turned negative for the first time since the 1960’s. Prices are falling. Normally that’s a bad thing because we will just delay making purchasing decisions if we feel that by waiting, the things we want to buy will become cheaper. I’m not talking about food and essentials like that, but cars, clothes, electrical items. Put up with your old stuff for now, because next year you can replace them for bright shiny new stuff – and cheaper than today. Economies go nowhere when people don’t spend.

You say Deflation, I say Dis-Inflation

It looks like a play on words but it isn’t. Dis-Inflation is what we have now. Stuff is cheaper because of;

• Cheap oil (a combination of over-supply due to the technology of fracking and other cheap energy sources due to the accelerating technology being created in Solar cells)
• Amazing Technology (Witness the productivity breakthroughs with computers, the labour saving due to robotics)
• The market size (It looks like we are no longer alone in the developed world, the whole of Asia wants to tote an iPhone and a Burberry handbag whilst driving a huge 4×4)

Blink and you will miss it

But enjoy dis-inflation whilst you can, it won’t be here for long. Soon it will be business as usual and back to good old inflation. I have written about what inflation does to cash isas here before with my blog all about Green Shield Stamps

For those retiring Inflation is important

Someone retiring today at age 55 could live for 40 years. Granted they would need a slightly better than average life expectancy. That same 55 year old today was 15 years old in 1975. For a 5.5p stamp to reach 54p over those 40 years required total inflation of 831.67% (I wrote that to two decimal places so you would believe me). Or put another way inflation over the last 40 years has run at an average rate of 5.88%. If that continues a second class stamp could reach £5.00 or more by the time the 55 year old dies. I doubt inflation will run at 5.88% on average again, but the bods at the Bank of England feel 2% per annum on average is reasonable, with our regulator preferring 2.5% per annum.

You cannot reach retirement and stand still because prices will overtake you fairly quickly. That’s why the investment return uncertainty of Flexible Drawdown, is a risk that usually has to be considered and taken. A level annuity just can’t keep up over the long term. An annuity that rises with inflation just starts too low today to make ends meet, unless you have an absolutely humongous pension fund. You can’t live for 40 years without keeping your pension fund invested.

The good news is that investment returns received over the last 40 years have trounced inflation and odds are they will continue to do so in the future.