The first thing we need to know about when it comes to understanding inflation is that the usual way of looking at it has changed. 

You used to calculate the rate of inflation based on the retail price index – the prices of certain baskets of goods and services.

Now, the inflation rate is calculated by the average market basket of consumer goods and services that are purchased by household’s CPI.

Essentially it’s a bit of a statistical estimate with inflation. They are trying to gauge what the average household is experiencing in terms of increasing prices.

Is rising inflation a cause for concern?

Recently, there has been a concern about increasing inflation rates when the consumer price index rose by 2.1% in 12 months to May 2021, up from 1.6% in April.

This was mainly a result of easing the Coronavirus restrictions and increasing oil prices, which has caused the economy to recover somewhat. 

There has been more spending now that we have started to go back to some sort of  normal, and more spending equals more demand, and supply and demand determine the price of everything.

So, as the economy is starting to open up again, we will potentially see increasing inflation rates in the UK.

The fund managers I talk to are telling me that we will see inflation at perhaps 2–2.5% by the end of the year, but then it will fall back again once we get back to a fully functioning economy. 

After the end of all restrictions, prices will increase in the short term, but the fund managers don’t see inflation of prices going forward in the years to come and certainly don’t see it as a major concern.

Who benefits from inflation?

One thing to keep in mind about rising inflation rates is that it reduces the value of debt and so it can be a good thing for some. For example, the UK government borrowed over £300 billion to cover the cost of the pandemic, so some inflation here is going to be a positive thing.

Ideally, the government wants the economy to expand every year and inflation to be at a norm of around 2%. This is the “Goldilocks” scenario for the economy and inflation, as it means that people are spending money but the prices are not rising enough to be a real issue. 

However, for those on a fixed income or who have faced unemployment, an increase in prices means that they can afford less on the limited income that they have going forward.

The rise in house prices this year is a good example of this and has been a real problem for some.

Those who are either furloughed or on very low fixed incomes are unfortunately going to be most affected by the rate of inflation, which we’re going to see this year.

Protecting the economy

Although inflation rates are on the rise, it is unlikely that they will lead to much of an increase in interest rates. The Chancellor and Bank of England want the economy to reflect where we were at pre-pandemic, and so will most likely keep interest rates down until we get back to January 2020 levels. 

As the economy expands, jobs will increase and, hopefully, salaries will increase as demand for people to be working in a growing economy rises. 

However, we are still not there yet, and it may take some time before that happens.

Protecting yourself against inflation

The best hedge against inflation has always historically been stocks and shares investments. Inflation has always traditionally been ahead of where interest rates are on banks and building society deposits. Money sitting in banks and building societies traditionally has lost value in real terms against inflation.

Fixed interest investments don’t usually beat inflation by much over the medium to longer term either.

It’s equities that have been the way to overcome any inflation. The returns and usually the dividend income from good UK equities (or in our case, well-managed investment funds for clients and investments, ISAs, pensions, etc.) have, over the medium to long term, always outweighed the rate of inflation.

And when you include the income from them, and the capital appreciation over the long term, then they’ve usually been considerably better than inflation too. 

If people are looking to counteract inflation, then having some equity exposure in their investment portfolio is something that they should seriously consider.

What investments are the right ones?

The gold standard of investment advice in the UK is always going to be independent financial advice, and we would always recommend your first port of call is to go and talk to a well-established, long-serving, experienced, independent financial adviser.

They will be able to review the whole of the economy, the inflation, the investments, the stock markets both in the UK and overseas, and come up with a plan to provide you with a portfolio that will help to combat the effects of inflation and suit your needs, requirements and attitude to risk.

 

I hope this has been useful, and if you have anything else to add, I’d love to hear from you. To find out more, feel free to get in touch by emailing david@applewoodindependent.co.uk.

The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.

The value of your investment can go down as well as up, and you may not get back the full amount invested.

Past performance is not a guide to future performance.