The Government’s official inflation measure jumped to its highest level in two-and-a-half years last month, tightening the squeeze on household spending power and increasing the challenge for savers.

The consumer prices index (CPI) increased to a higher-than-expected 4.5% in April from 4% in March, the Office for National Statistics says. Economists had expected the rate to rise to 4.1%.

However, the more representative retail price index (RPI) measure which, unlike CPI, also includes housing costs, fell marginally from 5.3% to 5.2%, though that still means prices are rising sharply.

The RPI fall came from a drop in council tax and house prices, plus a fall in the rate of car insurance price rises.

However, other measurements that go into forming inflation figures showed no signs of easing up.

CPI was last higher in September 2008, when the rate hit a record high of 5.2%, and was last at 4.5% in October 2008.

The most significant month-on-month contribution to the rise in the cost of living came from air fares, which were driven up 29% by the timing of Easter.

Elsewhere, the increase in excise duties on alcohol and tobacco had a major impact.

Interest rates to rise?

The inflation rise is likely to step up pressure on the Bank’s Monetary Policy Committee (MPC) to lift interest rates from their historic low.

But any calls for a rate hike to curb soaring inflation are likely to be ignored, as governor Mervyn King and his fellow MPC members have already said they expect CPI inflation to peak at 5% later this year before falling back to the 2% target throughout 2012 and 2013.

Many economists now expect a rate increase in November after the Bank recently slashed growth forecasts.

What it means for savers

Soaring inflation means we all have to pay more for goods and services but it also means savers will see the value of their cash eroded.

Imagine you’ve 1,000 in the top 3.05% easy access savings account. After basic rate tax you’d have 1,024 in a year as you’ve earned 24 interest.

Now suppose that 1,000 is enough for ten weekly supermarket shops. If prices rise by 5.2% next year, you’d need 1,052 to buy the same goods.

So although your savings might have grown, the impact of inflation means what you can buy with the money has fallen, meaning your cash loses value.

With savers squeezed by low interest rates and high inflation, National Savings and Investments has reported strong demand for its inflation-beating savings certificates launched last week that pay RPI + 0.5% over five years (see the NS&I launch MSE News story).

Data provider Moneyfacts says there are no standard savings accounts (other than inflation trackers) available for any taxpayer that beat the 5.2% RPI measure.

Andrew Hagger, from financial website Moneynet, says: “The gloom for savers shows no sign of clearing and it’s likely to be sometime before the inflation returns to anywhere near the now meaningless 2% government target.”

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The 1.8 million fans who applied for London 2012 Olympic tickets must ensure they have sufficient funds in their account or risk getting hit with bank charges as payments begin to get taken.

Cash for tickets will automatically be taken from successful applicants at some point from today until 10 June.

But you should check your account now to make sure you have enough money to cover the cost if you are successful in getting all the tickets you applied for, as that may happen.

If you don’t have sufficient funds your application could be rejected and you could be fined by your bank or credit card company for going over your limit (see Martin’s Unfair Olympic tickets blog).

Even if the application is successful and you breach your limit you could be charged.

You should also ensure there is enough extra cash in your account, in addition to ticket money, for any bills or other key outgoings that will be taken out over the next month.

If you cannot transfer money you could try applying for an increase to your overdraft or credit limit to make sure you don’t get charged.

You will be notified by 24 June if you have been successful, although if you check your statement before then you will see whether money has been taken.

If you are allocated tickets and later decide you no longer want to go you will be able to resell them at face value early next year via an official London Organising Committee of the Olympic Games website.

However, even though you will pay for the tickets this May or June, you will not be refunded until next year.

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Inflation has risen to its highest level for two decades, heaping further pressure on the Bank of England to raise interest rates.

The Retail Prices Index (RPI) measure of inflation rose to 5.5% from 5.1% in January, its highest level since 1991, and also ahead of expectations of 5.3%.

The Consumer Price Index (CPI) rate of inflation rose to 4.4% in February from 4% in January, driven by increases in the price of fuel, food and clothing, the Office for National Statistics (ONS) says.

RPI is generally considered to be more representative as it includes housing costs, despite the fact CPI is the official measure used by the Government.

The CPI figure, the highest rate since October 2008, is now more than double the Bank’s 2% target, and is likely to throw weight behind the argument for hiking interest rates from a historic low of 0.5%.

Stubbornly high inflation in recent months has prompted calls for a hike in the interest rate, which last month was held for the 24th month in a row.

But weaker than expected economic growth figures revealing a shock 0.6% decline in GDP in the final quarter of 2010 dampened this prospect.

Economic theory suggests higher rates cut inflation as people are encouraged to save rather than spend, cutting demand for goods and services, and thus stemming the rise in prices.

The number of policymakers at the Bank who voted in favour of an interest rate rise increased last month but the majority of the Monetary Policy Committee want to wait to see how the economy fares in the first quarter of this year before taking any action.

Why inflation is bad news for savers

People saving money keep it for a rainy day or a special purchase, but also to make that cash grow.

While it will grow even on a 0.01% interest rate, if prices rise by 5.5% in the coming year, your cash will buy you a lot less in 12 months than it does now.

Imagine you’ve 1,000 in the top 3.01% easy access savings account, after (basic rate) tax you’d have 1,024 in a year as you’ve earned 24 interest.

Now suppose that 1,000 is enough for ten weekly supermarket trips. If prices rise by 5.5% next year, you’d need 1,055 to buy the same goods.

So although your savings might have grown, the impact of inflation means what you can buy with the money has fallen, meaning your cash is losing value.

Inflation tracks the previous year’s prices. Savers opening a new account are more interested in prices for the coming year.

Why is inflation so high?

Petrol and diesel prices hit new records of 1.29 per litre and 1.34 per litre respectively in February, driven by a rise in oil prices made worse by the recent uprisings in the Middle East and North Africa, the ONS says.

Transport bills, which were up 0.8% since January, were the biggest single factor pushing up CPI, the ONS added.

Utility bills were up 3.1% on the previous year after showing their biggest surge since 2009.

The price of clothing and footwear rose 3.6% in February, a record monthly increase, as retailers brought in bigger than normal hikes following the January sales.

There was some downward pressure on inflation, as alcohol and tobacco became cheaper.

The core rate of CPI, which strips out volatile elements such as oil and food, hit 3.4% its highest level since records began in 1997.

James Knightley, an economist at ING, says: “With higher fuel costs set to continue adding upward pressure, we see inflation pushing on to 5% in the next few months, which will increase the pressure on the Bank of England to be ‘seen to be doing something’ on inflation.”

Additional reporting by Guy Anker.

Further reading/Key links

Best rates: Top Savings, Top Fixed Savings

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