What falling inflation means for you

As the RPI hits zero for the first time in almost 50 years, we tell you the winners and losers of falling inflation...

A big, fat zero. That's the figure we were left to digest this week, when inflation fell flat for the first time in 49 years.

The Retail Prices Index (RPI) fell from 0.1% in January to 0% in February. In contrast, the Consumer Prices Index (CPI) rose to 3.2%, forcing Mervyn King to get out his pen and ink again and explain to Mr. Darling why it was above the government's 2% target.

RPI, CPI, who?

For those new to inflation, the RPI and CPI are two different ways we measure price rises. The Office of National Statistics (ONS) collects 120,000 prices from a basket of over 650 items each month and uses them to calculate inflation.

The main difference between the two measures is the RPI takes into account housing costs such as council tax and mortgage interest payments, while the CPI - the rate the government's inflation target is based on, excludes these factors.

The ONS basket of goods and services is reviewed annually to ensure it still represents kool Britannia. Among the changes this year, MP3 players, traditional DVD rentals and imported cheddar cheese are out, while MP4 players, rose wine and Blu Ray discs are in.

So who benefits from falling inflation?

Changes in the RPI are significant, as this measure of inflation is used to calculate a number of state benefit increases.

However, those receiving the state pension are protected from the recent inflation falls, and can look forward to a generous rise next month.

This is because changes in pension payments are based on the previous September's RPI figure - which stood at a much higher 5%.

Of course, the increases may not be as generous next year if the RPI stays flat or goes into negative territory. That said, pensioners are still guaranteed a rise, as the Government has pledged that state pensions will go up by at least 2.5% a year.

Those paying student loans could also emerge winners, as the rate used to calculate how much interest you pay is based on March's RPI figure - released next month.

Following several base rate cuts, the interest rate on the newer, income-based student loans (handed out from 1998) has already fallen from 3.8% to 1.5% this year.

If inflation remains stagnant, those on pre-1998 mortgage style student loans will benefit from interest free repayments from September. Younger graduates paying the income-based student loans may also benefit, although this yet to be confirmed. (You can find out more about how student loan repayments work here.)

Good for savers, really?

Believe it or not, lower inflation also gives savers something to smile about. Despite the recent freefall in the base rate, the value of your savings benefits from falling inflation, as in 'real terms' it is worth more.

For example, when inflation stood at 5% in September last year, a basic rate taxpayer would have had to earn more than 6.25% interest on their savings in order to beat inflation. With inflation at zero, even a lowly return of 0.1% means your money is growing in real terms.

Of course, your own personal rate of inflation may be higher than 0%. It all depends on what you spend your money on, and how much those goods have risen (or fallen) in price over the past year. 

The losers

Where there are winners, there will also be losers, and while recipients of the state pension are set to benefit from above-inflation payments, some recipients of private pensions will suffer the opposite fate.

For example, those who bought index-linked annuities will see their incomes fall if inflation continues its decline. Yet often these pensioners have paid a 35% premium for this type of policy, rather than a standard level annuity where the amount of income you receive stays the same every year, regardless of inflation.

It's also important to remember that while those on the state pension are getting a better deal, pensioners spend more on items which have continued to rise in price, such as food, and less on things that are falling, such as electronics. This will eat into the gains they'll make on the State benefit rises.

It's a similar story when it comes to savings. Those with inflation-linked savings rates, such as the Index-link Savings Certificates from NS&I, will be getting much lower returns this year as these accounts track the RPI.

In addition, many people - such as tenants and those on fixed rate mortgages - are not benefiting from the fall in mortgage costs, and also have to fork out for the rises down the supermarket aisles.

A question of money

There's also the important issue of pay.

Most employers use the RPI to calculate wage increases, and while many workers in the public-sector struck three-year pay deals with the government ranging from 2.3% to 2.6% last year, others may not be so lucky.

With April pay reviews on the horizon, many of us will be bracing ourselves for a pay freeze or in some cases, a cut.

Of course, it's all very well making generalisations, but the only way to calculate the true impact of inflation on you is by using a personal inflation calculator. The results often surprise, and are often very different from what those boffins will tell you.

Finally, the biggest loser from falling inflation could be our economy. While short term price cuts will no doubt be welcomed, a sustained period of falling prices could do more harm than good.

After all, why would you want to splash out on that brand new car now, when you know it will be cheaper next month?

However, if nobody is buying, this eventually leads to a slowdown in manufacturing, meaning more jobs are lost, and ultimately leaving us with a very sticky situation to deal with.

Let's just hope it doesn't come to that...

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