What next for inflation and interest rates?

Following last week's surprise comments from the new Governor of the Bank of England, we look at what the markets think may happen to inflation and interest rates over the coming years.

Last week Mark Carney, the new Governor of the Bank of England, gave a very strong signal that he wants to keep the Bank of England's base rate at 0.5% for a long time yet. His statement effectively said that financial markets had become over-excited and were expecting a rate rise too soon.%VIRTUAL-SkimlinksPromo%
So you might be wondering: have the financial markets listened? Do they now think that interest rates will stay lower for longer? And will inflation go up soon?

Interest rates
Let's start with interest rates. Look at this chart from the Office for Budget Responsibility (OBR) back in March. It shows that the market was expecting a base rate of around 2% by early 2018 – up from 0.5% right now.

Source: Bank of England, HM Treasury, OBR

That's a useful chart, but it was published in March; we need to figure out what the market is thinking right now in July. One approach is to look at yields on Government bonds known as gilts. (Read about how gilts work in Why gilts matter.)

UK benchmark yields up to five years


Yield now

Yield one week ago

Yield one month ago

One month




Six month




One year




Two year




Three year




Five year




So if you look at, say, the yield on one-year gilts, it's fallen from 0.37% a year ago to 0.35% now.

To be clear, these yields aren't precise predictions of where the base rate will be in the future. Various other factors also affect these yields.

But these figures do show the market's sentiment on where interest rates will go. The table shows that most yields have fallen over the last month. In other words, the market now expects the base rate to stay lower for longer. Last week's statement from the Bank of England has made a modest impact on market expectations.

So most likely, the base rate will stay at 0.5% until 2015, and it will only rise gradually from that point onwards. That said, longer-term rates will probably start to rise well in advance of that date as the market tries to stay ahead of the game. As long-term rates rise, new fixed rate mortgages should start to become more expensive too. Annuity rates may also start to pick up at the same time.

So what about inflation? Here's how consumer price inflation (the Government's favourite measure) has moved over the last three years:


Inflation rate

May 2010


November 2010


May 2011


November 2011


May 2012


November 2012


May 2013


You can see from this table that inflation has been consistently higher than the Bank of England's 2% target. And, of course, retail price inflation - an alternative measure of rising prices – is nearly always higher consumer price inflation.

You can see how inflation affects your own finances by using this calculator.

Looking forward to future inflation, we can consider what City economists and other institutions are predicting. The Treasury publishes an average of these independent forecasts, and the latest numbers show a slight fall in predicted inflation for next year.

The average prediction for inflation in the last quarter of 2014 is now 2.4%. That prediction has fallen from 2.5% in May. I suspect that the inflation forecasts will edge up again this month in response to last week's statement from the Bank of England, but it's too early to say for sure.

But the overall message is that inflation isn't about to take off despite what some pundits would have you believe. The UK economy is showing slight signs of recovery, but there's plenty of spare capacity in the economy so businesses can increase their output without having to increase wages or pay more for commodities or other services.

That said, although inflation will remain relatively low in 2014, it will still be well ahead of interest rates on most savings accounts. So things aren't getting any better for savers any time soon.

7 ways to improve your retirement
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What next for inflation and interest rates?

If, like many Britons, you have failed to save the cash you need to maintain a comfortable standard of living in retirement, one option is to sell your home and downsize to a smaller property, using the money leftover to cover your living costs.
If moving out of the family home is too much of a wrench, however, the good news is that equity release schemes allow you to stay in your house or flat while still using the equity built up in it to provide some extra cash. The downside of the schemes, which work a bit like mortgages, is that you may not have much left to pass on to any children or other relatives.
But that's a small price to pay for a reasonable standard of living. For more information, try Age UK on 0800 169 6565.

Choosing the right annuity can have a significant impact on your retirement income. And as with most pensions, you automatically have what's called an 'open-market option' (OMO), you can scour the market for the highest annuity rate.
It is worth checking what your pension provider is offering first, though, as some companies offer guaranteed rates for existing customers that are likely to beat those available elsewhere. The Pensions Advisory Service on 0300 123 1047 is a good place to get some free advice.

On retirement, most people convert their pension fund into a guaranteed income annuity that pays out the same amount every month for the rest of their lives.
However, you can also choose an increasing annuity that pays out smaller amounts in the first few years but offers larger payments further down the line. This may prove a wise move if the rate of inflation remains at over 2%.

It is now easier to work later in life because the "default retirement age" has been scrapped.
People approaching retirement age and worrying about money can therefore choose to work for a few years longer - potentially transforming their financial situation. Other than the extra income from working, these people can look forward to higher state pensions, and higher annuity rates due to their greater age.
They can also benefit from bigger tax allowances and the fact that they no longer have to pay National Insurance contributions. Check out this nidirect website for more details.

You could get a much better rate with an impaired-life annuity if you have a medical condition that is likely to reduce your life expectancy.
Incredibly, even snoring, which is a common symptom of Sleep Apnoea could have an impact.
According to figures from MGM Advantage, a man with this condition could receive an extra £12,000 retirement income over the course of their retirement - or £571.44 extra money each year. Click here to find out more.

To maximise your retirement income, it is vital to ensure that you are receiving all the benefits to which you are entitled. These include the basic State Pension, and in some cases, the additional State Pension.
If you are on a low income, you could also qualify for the guaranteed element of Pension Credit, while those with some savings may get the savings element of this benefit. For more information about these and other benefits such as the Winter Fuel Payment, click here.

Many older couples rely on the pension income of one person - often the man. Should that person die first, the other person can therefore be left in a difficult position financially.
One way to prevent financial hardship for the surviving person is to take out a joint life annuity that will continue to pay out up to 67% of the original payments to the surviving partner should one of them die.
The disadvantage of this approach, however, is that the rate you receive will be lower. Again, the Pensions Advisory Service on 0845 601 2923 is a useful first port of call if you are unsure what to do.

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