This post originally appeared on the Nutmeg blog, where I occasionally contributes articles on personal finance.
There will be a number of factors that will affect your personal finances in 2012. I take a look at some of these below:
Inflation as measured by the Consumer Price Index fell to 4.2% in December, down from 5.2% in September. While obviously good news for personal finances this is still well above the Bank of England's official target of 2%, a target which the Bank of England does not anticipate meeting until 2013. While inflation is expected to fall throughout 2012, particularly as last January's VAT hike drops from the Office of National Statistics’ official inflation calculations, those on fixed incomes will continue to see the spending power of their income eroded by inflation.
With the average deposit account earning around 3% per annum (which when taking inflation into account this drops to a real interest rate of -1.2%) money held on deposit will continue to lose value in real terms. This status quo will be maintained until inflation returns to target and/or savings rates rise. Neither will be happening any time soon.
Ironically those with debts benefit from negative real rates. If they can maintain the interest payments on their borrowings then in real terms their debt is decreasing. Some would argue this is exactly what the UK Government is attempting to do with our national debt.
But while the current rate of inflation will affect people's finances (reducing the value of both the pound in their pocket as well as the debt on their credit card) past inflation rates will also bear influence in 2012. Increases in a host of social benefits (from job-seeker's allowance to the basic state pension) and tax breaks (such as the annual ISA allowance) for the 2012/13 tax year have been based upon the rate of CPI from September 2011.
While the headline inflation number grabs the headlines there are deflationary pressures out there. Fears over the UK (and the rest of the world) falling back into recession coupled with the highest unemployment rate (8.4%) since 1996 will keep a lid on pay rises. Until inflation and unemployment levels recede real income levels will continue to fall, squeezing personal finances. Companies will be loathed to expand and recruit in an uncertain economy where consumers are choosing to save or pay down debt rather than spend. With government austerity measures reducing both public sector spending and employment the vicious cycle will likely conspire to keep real wage growth low.
The Bank of England Base Rate
The Bank of England (BoE) has held its base rate at 0.5% for 34 months at the time of writing. With millions of homeowners’ mortgage repayments directly influenced by the official base rate it remains a key influence on the nation’s personal finances.
However ,weak economic growth and falling inflation have lead markets to not texpect a rate rise until the end of 2015. But predictions are notoriously inaccurate. Last February markets were pricing in a rate rise within two months with absolute certainty. Clearly they were wrong.
But while it seems unlikely that rates will move in 2012 they continue to influence the nation’s finances by allowing some to keep their heads above water.
While a movement in the Bank of England Base Rate is unlikely there is the potential for further Quantitative Easing (commonly referred to as ‘Money Printing’). This would add to the £75 billion worth announced last October to kick-start the UK economy. While not immediately obvious, more Quantitative Easing (QE) will have an impact on personal finances in a number of ways.
But to understand how, you need to understand how QE works. The BoE doesn't actually print money but instead buys swathes of assets, in this case government loans (aka gilts), from institutional investors with 'new money' created electronically. The effect is to drive up gilt prices due to the increased demand (and therefore drive down gilt yields - remember when gilt prices go up the yield goes down and vice versa).
In a new round of gilt purchases by the Bank of England the potential return on gilts would likely fall in tandem with gilt yields. Given that gilts are the investment cornerstone for defined benefit pension schemes’ ability to match future liabilities, if investment returns are hit then schemes may fall into funding deficit.
Similarly Annuity Rates are based on long-term gilt yields. So if gilt rates fall so will annuity rates meaning that people nearing retirement could receive less income than they would have otherwise when they buy an annuity with their defined contribution pension pot (i.e. a personal pension plan).
Following the announcement of QE UK equity markets may pick up. While risk assets (such as equities) rallied after previous QE efforts both here and in the US, markets had already priced in the last bout of UK QE. But any effects will be dependent on the timing and size of any QE announcement.
Holders of 10 year gilts (and possibly investment grade corporate bond) would obviously benefit from price rises. On the flip side gilt yields will fall meaning the income return on gilts will fall. But the problems in the eurozone remain the biggest threat to investors at the moment (see below).
Sterling - quite simply, pushing more money into the economy makes the value of the pound in your pocket worth less. Unsurprisingly the Sterling exchange rate briefly fell against major currencies after the last QE effort announcement, falling by 1% in a minute against both the Dollar and the Euro. Obviously if such a pattern were to repeat,your holiday spending money will get a bit more expensive.
Borrowing - by driving down gilt yields the cost of borrowing should be driven down for banks and therefore borrowers. Cheap credit encourages people to borrow more and spend rather than save money and pay off debt. The former drives the economy while the latter slows it down.The theory is that we should see signs of increased lending activity to businesses and consumers. However, don't hold your breath on this as if history is to repeat itself then increased lending may not materialise to the extent policy-makers are anticipating.
As a nation of homeowners the value of property is key to people’s perceived wealth. I say perceived as for owner-occupiers any losses or gains on the value of their property is only crystallised if they move. But a faltering housing market could lead to increased numbers of borrowers unable to remortgage or get on the property ladder.
This in turn will drive up rental yields which will be bad news for renters, but good news for landlords. So where are house prices headed in the near future? You need look no further than housing transaction volumes. In a classic example of supply and demand economics driven mostly by the availability of credit, if no one is buying houses prices will fall.
Since the middle of 2008 monthly transaction volumes have been fluctuating between a low of 40,000 and a high of 60,000, which is less than half the volumes seen during the boom in 2006! These figures indicate that we are currently in a sideways trend with volumes, and therefore prices, showing no sign of an improvement in the short to medium term.
While we may not be part of the eurozone, and have our own currency, the sovereign debt crisis will have a major impact on our finances. The current credit crisis has the potential to blow up into a full scale banking crisis. Inter-bank lending has become more expensive as banks try to limit their exposure to sovereign debt issues. The inter-bank lending rate ultimately determines the cost of consumer borrowing, which is why some mortgage rates have started to creep up despite the BoE base rate remaining at 0.5%. This theme will continue throughout 2012.
It almost looks certain that Europe will slide back into recession dragging the UK with it, and bringing all that it entails. On the plus side our currency has strengthened making imports and holidays cheaper. However, this trend could be reversed if markets perceive the UK to be struggling with its own debt pile.
Elsewhere, the European Court of Justice ruling will mean that from December insurers will have to treat men and women equally when underwriting insurance premiums and annuities. This will likely mean that women will see life and car insurance premiums rise. On the flip side female annuity rates will likely rise at the expense of men’s.
From October 2012, employees will start to be automatically enrolled into company pension schemes. The government driven scheme aims to give 10 million workers access to pension saving for the first time.
Implementation will be staggered, with the biggest employers expected to start enrolling their employees first. The timetable for implementation depends on the size of individual firms with those with under 30 employees having until April 2017 to implement.