How cheaper goods could leave your finances in the cold

By Rachel Jones
Know Your Money Editor

The Retail Prices Index (RPI) has dropped to zero per cent, almost tipping the UK into a period of deflation. Such a low figure has been pushed down by a decline in property prices and falling energy and gas costs, which should, in theory, mean Britons have more money in their pockets. However, if the RPI does drop below zero per cent and into negative territory then wage cuts and freezes could be on the cards for taxpayers up and down the country. Workers in the public sector are particularly at risk because their wages are tied to the RPI. Teachers, council workers and nurses could all face an income freeze as the credit crunch continues to clamp down on the cash of households.

General secretary of the Trades Union Congress Brendan Barber says: "While many workers in companies hit hard by the recession have agreed modest or even zero increases in pay to save jobs, a generalised wage freeze across the economy will make the downturn worse, not better."

But what have the RPI figures released by the Office for National Statistics (ONS) got to do with the pay packets of Britons?

Household coffers could come to a standstill

The Bank of England's current interest rate of 0.5 per cent means that fewer mortgage repayments are being made and, when combined with tumbling property prices, leaves the financial coffers of the country running low. When the RPI falls below zero, businesses have to take action and price cuts could follow. A lack of cash in the pot could lead to job cuts. If this occurs, there will be less demand for goods and a depression may follow. To avoid job losses, many firms prefer the option of dishing out wage cuts and freezes.

David Kern, chief economist at the British Chambers of Commerce, tells the Times: "Wage freezes will become much more widespread. When you're looking at a pay freeze, it is often the difference between having a job or not."

In order to work out the RPI, a "basket of goods" is used to gauge what level spending and prices are at. Different items are taken out or placed in the basket by the ONS each year to account for changing consumer habits. A preference for rose wine, free range eggs and hot rotisserie chickens has been reflected on the list, while MP4 players have replaced MP3s. Meanwhile, DVD film rentals have been replaced by the current trend of hiring films from an online company.

The government uses the RPI to set the level of welfare benefits, state pensions and index-linked government bonds. If employers think that people are earning enough to see them through the recession, they will freeze their salaries until the RPI starts to rise.

Deflating the UK

John Philpott, chief economist at the Chartered Institute of Personnel and Development, says people may want to prepare themselves for a drop in their income.

"This is an exceptional experience. When the UK last entered an annual pay round with zero RPI inflation, Elvis was still in his pomp, Cliff Richard was still hip and the Beatles were still unknown," he points out.

"And at that time the trade unions were still strong enough to prevent pay from falling along with prices. But in today's flexible labour market pay is better able to adjust downward when inflation falls."

However, while deflation may be bad news for those in debt, who could be armed with less of an income to clear the cash they owe, savvy savers could benefit from a negative RPI. Even for those earning no interest, their cash can go further, leaving more money in the coffers for when prices start to increase. This could mean that households forking out for big purchases now could find themselves with plenty of spare change to carefully stash away.

Stashing cash away for a price hike

Individuals are spending their hard-earned money more carefully in order to make their pennies go further. According to Abbey Credit Cards, the average UK wage of £25,100 is being stretched by seven per cent because of careful money management. This could be of particular importance for Britons who fear a wage drop or freeze. Indeed, 37 per cent of shoppers claim they search for an item in at least five shops to find the cheapest deal and 31 per cent trawl car boots sales to bag themselves a bargain. The survey also shows that four out of ten shoppers try haggling to push down the prices of their purchases.

Commenting on the findings, Callum Gibson, head of credit cards at Abbey, says: "At a time when people's finances are becoming ever more stretched, it's not surprising that Britons are becoming more astute about how they shop and are prepared to shop around and economise to make their money go further."

As such, Britons may want to search for the best savings accounts on offer to shore up their money while the RPI is low. The FirstSave one-year fixed-rate bond currently pays out 3.6 per cent in interest with a minimum balance of £1,000. Meanwhile, the Halifax fixed-rate web saver has an annual equivalent rate of 3.5 per cent and requires a minimum balance of just £100. These and a comprehensive list of other savings accounts on the market can be found at Know Your Money's Compare Savings Accounts page, .