PROTECT YOURSELF FROM INFLATION

THIS week was supposed to be about how to maximise the return from your savings in these difficult times, but the latest Central Statistics Office report about price inflation has pre-empted it; how to protect yourself from inflation is more of a priority. You need to protect your savings first before coming up with a strategy to maximize them.

THIS week was supposed to be about how to maximise the return from your savings in these difficult times, but the latest Central Statistics Office report about price inflation has pre-empted it; how to protect yourself from inflation is more of a priority. You need to protect your savings first before coming up with a strategy to maximize them.

Ordinary people are being battered from all financial sides in Ireland today.

The bank crisis continues relentlessly. The new government is desperate to secure better repayment terms from the EU for the huge loans we’ve had to borrow; the size of the bank and sovereign debt we’ve accumulated since 2008 grows exponentially. We have to find a way to balance our €34 billion tax revenue with our c€55 billion national budget, but the new government is unwilling to make the level of cuts in its two biggest spending categories – public sector pay and pensions and social welfare – while at the same time acknowledging that taxation alone, and it will be significant, can’t plug the hole.

Meanwhile, as the price of our main asset – our homes – and our incomes keep falling, the first wave of really serious price inflation for several years is hitting these shores, nearly three years after US and other global central banks turned their money printing presses on high to ‘save’ the global private banking system.

In its latest report, the Central Statistics Office announced that the annual rate of inflation has jumped to 2.2%, up 0.7% from last month and has increased by 5.4 percentage points from where it was a year ago when it was -3.2%

Housing and fuel prices are up 9.5%, liquid fuel by 37.3%. Private health insurance is up 14.4%; clothing and footwear, 6.5%. Transport costs are soaring, especially plane travel, up over 20%. Even butter costs 3.8% more than last year.

The monthly rate of inflation in February rose from -0.2 in January to 0.9%. If it rose by that 1.1% for each remaining month of this year we would end up with an annual inflation rate of just over 12% in 2011! Wages are effectively frozen or falling and savings are netting gross returns of c2%-3%.

It would take a pretty devastating increase in oil and food prices to cause that level of inflation here or in the eurozone and the ECB would certainly move to slow it with an even sharper rise in interest rates (and not just the 0.75%-1% we can expect by the end of 2011.)

But higher interest rates will only accelerate the personal and mortgage debt problem here, though it might be good news for savers if those rate increases were passed on to them.

The series of meetings this month between EU Finance ministers and the ECB about the cost of economic bailouts and reform, the solvency of European banks and the inflation problem that has developed will have important consequences for everyone in Europe, but especially for us in Ireland.

I think the effect of inflation and/or high interest rates will be pretty devastating. Any decisions made by the ECB will not be made for our benefit, which is why it is so important that you not just sit by and wait for them to move.

If you are on a low income, a 5.4% jump in inflation over the past year was the equivalent of another 5.4% tax. If it happens again this year, you can only avoid it if you cut your expenditure. This will be difficult but inevitable. Do another budget. Can you earn any more money to make up the loss? Is there anything you can sell or do without?

Anyone with savings needs to also accept that the spending power of their money is falling. If you have all your life’s savings in cash, from which you need an income, you need to consider shifting some of it into assets that might benefit from inflation – like rock solid, blue chip stocks and shares that pay annual dividends. ‘World dominators’ – big energy and consumer stocks fit this bill since they produce goods and services people keep buying, even in the bad times. (Companies like Coca Cola, Gillette, Unilever, Intel, Microsoft, McDonalds, Exxon all fall into this category.)

Currency debasement and devaluation risk can be reduced by shifting a portion of your cash into precious metals. You certainly should avoid taking on new debt you can’t afford to repay easily, or that is not fixed at the lowest interest rate possible.

Can inflation go much higher? Some commentators think not. They believe energy prices will fall as demand falls and stockpiles improve. They believe central bankers can adjust their money levers and raise interest rates just enough to curb higher prices but not so much as to push business costs up. I don’t share this view: I think the money genies are out of their bottles and won’t be easy to recapture.

Here in Ireland higher prices may spur some people to spend some of their savings (which are losing spending power) but higher taxes, the fear of job losses will stop many more.

Instead it looks like whatever wealth you do have – savings, investment or pension funds will need to work harder to beat the triple threats of higher taxation, higher prices and lower incomes.

Next week I’ve asked three, independent advisors to share with you their top investment funds and assets choices and also what people should do if they have their life savings entirely in cash.