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Deflation is an ugly spectre. Plummeting prices for all sorts of goods and services may be welcomed by cash-rich people who can still afford to go shopping. But for the rest of us it means rising unemployment and more cuts in interest rates - bad news for anyone relying on their savings for income.
How can you protect yourself? If you are working and worried you soon might not be, take out payment protection insurance to cover your important debts, especially your mortgage, for up to a year. We will run an article on this next week, but the most important thing to check is that you will actually qualify for a payout: the small print can be riddled with catches.
Cuts in the base rate have not been passed on to credit card, overdraft and personal loan borrowers, while the rates on some of these unsecured debts have gone up, and are far higher than anything you can earn on a savings account. So Martin Bamford of independent financial adviser Informed Choice says the best thing to do with spare cash is to pay down debts.
If you are relying on savings, make sure you lock in to the best fixed rate you can get and use your tax-free Isa allowance. David Black at Defaqto says Halifax's Stepped Income Reserve will pay an average of 5.5 per cent over five years, while over one year Birmingham Midshires is paying 5.6 per cent.
As for pensioners, Nigel Callaghan of Hargreaves Lansdown points out that many who have taken out an inflation-linked annuity will find their income reducing if deflation occurs. Some insurers, including Axa, Partnership and Liverpool Victoria, do not limit the amount annuity income can drop by, while Prudential and Standard Life sell some annuities with floors, and some without. Be careful what you buy.
He adds that inflation needs to run at 5 per cent a year for an RPI-linked annuity to be worthwhile; an annuity fixed to increase by 3 per cent a year is currently better value and will increase even in the event of deflation.
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