Inflation: The ins and outs

Should we worry about post-COVID-19 inflation? And as prices inch up now that lockdown restrictions are easing, how might this affect investors? Read our latest article to stay informed of the latest news about inflation.

Overview:

  • Inflation tracks the change in price levels, resulting in money losing its purchasing power as time goes on.
  • Increasing inflation may cause problems for those with large amounts in cash, as long as the current low interest rates remain below inflation. That said, cash may still have a role to play in a portfolio.
  • Contact your Wellesley financial adviser to better understand how our fund managers can position your investments for the future.

As post-lockdown life has seen COVID-19 restrictions gradually easing, and consumers have been able to get out and about to spend their savings, ‘inflation’ has increasingly made the headlines in the financial news. But what’s the underlying reason for this increase, and should you be concerned?

Inflation – what is it?

Simply put, inflation is the rate at which prices of goods and services are rising, and it results in money losing its purchasing power over time. In the UK, the Office for National Statistics (ONS) tracks inflation, collecting 180,000 prices of 700 items as part of a sample ‘basket of goods’, thereby measuring price changes as time goes on. These items range from clothing, footwear and food & drink, to transport and restaurants.

A certain level of inflation is expected by governments and central banks in order to help the economy grow. If prices are steadily increasing, people are encouraged to spend now as opposed to later, to avoid future price hikes. Furthermore, it enables companies to increase their prices and wages, in order to grow and pay down their debt.

Nevertheless, the impact of runaway inflation is no secret, in that it can wipe out purchasing power – if the value of a currency falls faster than people can spend their salary, this leads to tangible assets being hoarded – resulting in a ‘capital flight’, as people try to take their money out of the country to seek stability.

Central banks and governments therefore aim to maintain inflation at a low and reasonable level. In the UK, the US and many other developed economies, the target is 2%.

What’s the current situation?

The past year or so has witnessed a significant economic slump, with supply chains severely disrupted and many consumers obliged to stay at home – often saving their money as a result. At the same time, governments added liquidity to the system, thanks to low interest rates and various loans and payments to companies and individuals.

Now the heat of the pandemic has cooled off, consumers have returned, and they’re keen to flash the cash. On the other hand, in some cases, supply chains have not recovered as quickly, meaning prices have taken an upsurge. Take cars, for example – demand for used cars has vastly increased as the lockdown has eased, with the stock of used cars remaining low, which has led to increasing prices.

Inflation is usually reported by way of comparison to the previous 12 months, and so inflation for Q2 2021 is compared to Q2 2020 – when prices were quelled by the first lockdown, and oil prices had crashed following an OPEC stand-off.

All this has meant an increase in inflation throughout much of the Western world.

One way that inflation can be controlled is by raising interest rates. Increasing the cost of borrowing results in consumers and businesses having less to spend, meaning that the amount by which businesses can increase the costs of their products is also reduced. What’s more, higher interest rates make saving cash a more appealing solution, too.

At the moment, rates are at an all-time low, hovering slightly above 0% in many Western economies. Given that inflation is inching above the 2% target, some investors are predicting a rate rise in the future. For the time-being, however, the Bank of England and the US federal government see the current inflationary trends as “transitory” – and are therefore unlikely to make any snap decisions.

What does inflation mean for savings?

Higher inflation means your money needs to work harder for you, so you don’t lose that precious purchasing power. Due to low interest rates, increasing inflation may be problematic for individuals with large amounts in cash, as long as interest rates remain below inflation. Nevertheless, cash may still have a role to play in a portfolio, thanks to its flexibility, liquidity and security.

Inflation isn’t necessarily a negative for those with investments in equities, however. On the one hand, it does mean you need your money to work that bit harder and earn fractionally higher returns to generate a return above inflation. And for some companies, it might reduce profits if they’re unable to share these price increases with their customers.

On the other hand, it’s often the case that higher inflation helps to boost a company’s debt situation, with many companies being able to pass on increased costs direct to the consumer – for instance, in mobile phones, insurance and utilities.

This is just one reason behind the importance of diversification. It’s unrealistic to think that one sector could outperform other sectors for ever, and as inflation increases, some investments may perform better, whereas others may need some adjustment.

What’s also noteworthy is that inflation is no newcomer. It’s constantly in the background, and fund managers have always accounted for it in their strategies. Furthermore, it’s just one in a matrix of considerations fund managers keep track of and respond to over the long term.

At Wellesley, our clients have access to a wide range of investment solutions. By investing in a range of assets and companies, potential protection against the harmful effects of inflation over the longer term is available.

As always, the Wellesley team are here to alleviate any financial concerns you may have – to learn more about inflation and how your investments can be positioned for the future, don’t hesitate to contact your financial adviser today on 01444 244551.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and the value may therefore fall as well as rise. You may get back less than you invested.

An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society, as the value & income may fall as well as rise.

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