Living costs are on the rise, so we look at where to get the best deals on investments, savings and spending.

Savers were dealt a blow last week after a record spike in inflation meant that, for only the second time in a decade, no variable savings accounts are paying a positive return.

The consumer prices index (CPI), the government’s preferred measure of inflation, soared from 1.9% in November to 2.9% in December — the largest jump in the annual rate since records began in 1997 and well above consensus predictions of 2.6%.

Higher-rate taxpayers now need to find an account paying at least 4.83% gross interest to beat inflation and tax. Basic-rate payers need 3.63%. However, not a single variable-rate savings account pays interest above 3.63%.

Andrew Hagger at moneynet.co.uk, a price comparison site, said: “It is a rarity to see no variable accounts paying enough to beat inflation. The only other occasion this has happened in recent memory was between July and September 2008, when CPI hit highs of between 5.2% and 5.5%.”

The retail prices index (RPI), which includes costs such as mortgage interest and council tax, also increased last month, rising from 0.3% to 2.4%.

Inflation data is set to show another rise of more than 3% in the year to January when Vat and stamp duty increases took effect.

However, minutes of the Bank of England’s monetary policy committee meeting on January 7, when members voted to keep Bank rate at 0.5% for the tenth consecutive month, state the MPC expects inflation to fall again “once the various near-term shocks to inflation had worked through”.

Most economists expect Bank rate to remain on hold until October, rising to 1% by the end of this year and 2.5% in the second half of 2011, according to a poll published by Reuters.

However, some analysts think rates will rise faster. Simon Ward, economist at Henderson, said rates were likely to rise before the election, which is tipped to take place in May, and hit 2% by the middle of the year.

Rising interest rates should be good news for savers, but analysts said the benefit could be wiped out by higher inflation — while borrowers would also see sharp increases in their repayments.

Meanwhile, average earnings including bonuses rose a mere 0.1% in the year to November, up from 0.6% in October. Private sector pay including bonuses fell 0.1% against 3.8% growth for the public sector.

We look at how households can overcome the inflation spike.

SAVINGS

There are 261 easy-access savings accounts on the market, according to moneysupermarket.com, the comparison site, but none pays enough to negate the combined effects of inflation and tax.

Savers can seek some respite by investing the maximum allowance in their Isa because any interest earned is tax-free. The cash Isa allowance will increase for everyone from £3,600 to £5,100 on April 6, having already risen for the over-fifties from October. No easy-access Isas provide a real return — the best rate is 2.65% from Standard Life Bank — but you can earn more if you lock in longer.

The top-paying Isa is the five-year fix from Leeds building society at 4.60%, though you run the risk that interest rates will rise during the term. Over shorter periods, you could go for the one-year bond from Aldermore at 3.05% or its two-year bond at 3.6%.

Index-linked savings certificates from National Savings & Investments, the government’s savings arm, also look a more attractive bet following the inflation spike.

The NS&I certificates, which are tax-free and available in three-and five-year terms, pay 1% plus RPI if inflation is positive from one anniversary to the next. At present, this gives tax-free returns of 3.4%, which is equivalent to a gross rate of 5.67% for higher-rate taxpayers and 4.25% for basic-rate ones. Danny Cox at Hargreaves Lansdown, the adviser, said: “They are 100% guaranteed because they are backed by the Treasury and investors can tuck away up to £15,000 in each type of certificate — which gives a total of £60,000 between a couple. The rollover options available at maturity also allow investors to build large, inflation-busting portfolios.”

Tax-free savings and investments also have no impact on age-related personal allowances, which is important for over-65s whose additional personal allowance (£9,490) is reduced by £1 for every £2 of income between £22,900 and £28,930.

Regular savings accounts, which require you to contribute a certain amount each month, often pay more than easy-access accounts. For higher-rate taxpayers, 10 accounts pay interest of more than 4.83% but most require you to have another type of product, such as a current account, with the provider. Basic-rate taxpayers have more choice, with 23 accounts paying a real return, according to David Black at Defaqto, the data firm.

The highest rate on a regular saver that doesn’t require you to have an additional account is from Nottingham building society at 5%, which allows you to deposit £10 to £100 each month. The account, launched last week, is available only in branches.

Finally, savers looking for good rates have to take a gamble on when they think interest rates are going to rise because the best rates are available only if you are prepared to lock away your money. Halifax and Aldermore pay 5.15% on their five-year bonds, with Birmingham Midshires paying 5% on its four-year fix.

Black said: “You should fix only with money you know you are not going to need because early access is either expensive — in the form of penalties — or forbidden.”

The best rate on a one-year bond is from First Save at 3.65%, while ICICI pays 4.25% on its two-year fix.

MORTGAGES

Brokers are divided on whether last week’s inflation data was a call to fix. Andrew Montlake of Coreco, the mortgage broker, said fixed-rate mortgage costs, which have fallen recently, were likely to rise after the higher-than-expected inflation figures. He said all but the most equity-rich borrowers were leaving it “dangerously late to fix”.

However, Ray Boulger of John Charcol, the broker, recommends new borrowers continue to take out variable loans. “It is our belief that the best value lies in tracker rates,” he said. “With the average difference between the best fixed rates and the initial rate on the best trackers around 1.5% in favour of trackers, it will currently take a substantial rise in Bank rate for a borrower who takes a tracker to be worse off than one who opts for a fixed rate.”

One option is to mix and match or split your mortgage. You must take out two mortgages with the same lender, though only one arrangement fee is paid. For example, Woolwich offers a five-year fix at 5.49% with a £999 fee. It also offers a lifetime tracker at 2.63%, with a fee of £999. Under a split deal, you could combine them and pay only one fee. If you divided a £200,000 loan between the two deals, you would pay £613 a month on the fix and £455 on the tracker — a total of £1,069 against £1,227 if you had the entire sum in the fixed deal.

SPENDING

Air fares and seasonal food prices were among the surprising increases in last week’s inflation data — up 42% and 1.7% respectively. Bananas were 22% more expensive while the price of tea rose 4%.

To beat the price rises, consumers are flocking to comparison and discount sites to save hundreds of pounds on weekly shopping bills.

Instant price matching with Kelkoo, a comparison site, can be accessed on a mobile to compare prices while out shopping. You need to log on to http://m.kelkoo.co.uk — a specially designed price comparison tool for mobiles.

Kelkoo’s most popular search last week was an Acer Aspire 15.6-inch laptop, which costs £399.97 at John Lewis, or £579.79 at simplyacer.com — a difference of £179.82. The Canon EOS digital camera was available for £699.99 at Jessops compared with £779 at play.com, saving £79.01.

Meanwhile, thousands of iPhone users are downloading the “Red Laser” application. With its built-in scanner, it automatically detects a barcode on goods as the iPhone camera swipes past it. The device then scans Amazon and Google Product Search for the best online prices.

One “clearance grocery” website, approvedfood.co.uk, is selling short-dated or out of date “best before” dry food products and clearance stock. It is reporting a 500% increase in sales in the last 10 days of 2009, and claims tro have more than 25,000 customers.

INVESTMENT

The price of conventional government bonds (gilts) generally falls as inflation rises. Index-linked gilts, however, can act as an insurance policy because yields and capital rise in line with inflation. Institutions have driven up prices to expensive levels, however.

The yield on a conventional 10-year UK gilt is 4.48%, while that on the nearest maturity index-linked bond is 2.16%. The difference, known as the breakeven rate, shows expectations for inflation, so you would have to assume inflation above 3.16% a year for 10 years for it to be worth buying.

Investors have also piled into gold as a hedge against inflation. However, at $1,096 an ounce, the metal appears overvalued — the price is tipped to fall this year.

The easy way to benefit from moderate inflation is to buy good-quality equities, which should benefit as companies charge more for goods and services.

Analysts have been tipping “defensive” stocks such as Vodafone, the phone giant, Unilever, the consumer goods group, and Glaxo Smith Kline, the pharmaceuticals company.

ANNUITIES

Annuity rates are usually based on the yields on 10-year gilts, so should rise in line with expectations for higher interest rates.

However, Tom McPhail of Hargreaves Lansdown said conditions were “unusual” and annuity managers were reluctant to put up rates as the outlook was uncertain.

You could hedge your bets by splitting your pension into tranches and buying an annuity in stages.

McPhail recommends tranches of no less than £15,000 to get a good annuity rate — you can only get an “open market” annuity rate on a minimum of £5,000.

Paul and Natasha Motton, of Sandford, Dorset, pictured with their children Eloise, 4, and Jack, 17 months, have been on a standard variable rate since their fixed-rate mortgage with First Direct expired in July. This year, however, they have decided to remortgage on to a fixed-rate deal with Woolwich.

Paul, 39, a network analyst and Natasha, 35, a housewife, have applied for a two-year fix from Woolwich at 3.89%, which is available to borrowers with a 30% deposit.

VETTING HIS LOAN

Martin and Rebecca Iliott, of Windsor, pictured with their children Steven, 15, Rachel, 13, Michael, 11, and Jennifer, 5, have decided to remortgage on to a lifetime tracker.

Martin, 45, a vet, and Rebecca, 47, a teaching assistant, have only eight years left to run on their £70,000 loan and have equity of more than 75%.

While the deal they took with Woolwich at 3.19% was not the lowest rate on the market, they liked the fact it had free valuation and legal costs and no upfront arrangement fee.

Also the absence of any early redemption penalties means they are able to switch at any time should interest rates begin to rise.

Martin said: “We didn’t feel it was necessary to pay more for a fixed-rate deal. Our mortgage is small and I have budgeted for higher payments should interest rates rise.”

SWITCHING FROM STANDARD

Alexandra Goss and Elizabeth Colman From The Sunday Times

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