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It’s frequently said that inflation is the enemy of the investor, but what is it? It is commonly defined as the increase in price of general goods and services, so this article looks at how inflation manifests itself and how it can be good and bad.
Many economists expect inflation to rise in the months and years ahead and when it does it’s felt in the general cost of living, doing business, borrowing money and on bond yields, to name but a few things.
UK inflation is measured against two indices – the Consumer Price Index (CPI) and Retail Price Index (RPI) - and the most recent figures for the CPI represented a higher rise than expected - from 0.6% in August to 1% in September. The RPI, which includes mortgage interest payments, also rose, from 1.8% to 2%.
Since the UK voted to leave the EU our currency has weakened and many expect this to cause inflation to rise, which in turn increases the price we pay for goods, but the Office for National Statistics (ONS) has stated that there is no evidence to suggest that the weak pound has been responsible for the latest increases in inflation.
Rising costs hit the headlines recently when Tesco and Unilever were locked in a price war. Unilever manufactures products such as Marmite, Pot Noodle, PG Tips and Comfort and reports suggested that Unilever asked Tesco to pay 10% more for the supply of their range, principally due to Brexit. Tesco refused and removed many Unilever products from their shelves. The outcome - both companies saw their share prices fall and quickly agreed on no price increases.
Inflation proofing can prove difficult. Incomes need to keep pace with inflation so people don’t feel financially worse off. Businesses have a dilemma in balancing their books if costs increase and investors and those saving for retirement have similar issues, as inflation impacts the real value and return from the money they have invested.
Some people do benefit though. As the basic state pension has a ‘triple-lock’ guarantee attached to the payment, this ensures that the state pension payment increases at the higher of inflation, average earnings or 2.5%, so those in receipt of the basic state pension tangibly benefit - the maximum payment will increase to £122 per week from April next year. At the younger end of the scale, new parents will see a small increase in both maternity and paternity benefit payments, as these are linked to September’s inflation figure.
Individuals and families receiving tax credits and other benefits are likely to feel worse off, due to a freeze on any increase in payments, so if the price of goods rises and income in the form of benefits stays the same, they won’t be keeping up with inflation.
Many goods and services are imported into the UK from abroad and economists are predicting a further rise in prices of household items due to fall in the value of the pound making them more expensive to buy, so we will end up spending more for the same goods.
Savers with money held on deposit have seen their interest rates reduce in line with the reduction in the Bank of England Base Rate. If inflation increases their return will fall in real terms, meaning that cash may not be a good place to stay in the long term. Borrowers on the other hand have benefitted from falling interest rates, but this may not be the case in the long run, as one of the key weapons against inflation is to increase interest rates and lenders look to protect their margins.
Retirees who have incomes from pensions that are not inflation-linked could start to feel worse off if the prices of utilities and food increase, as their pension income may not keep pace.
To combat inflation, your money, be that savings or income after tax needs to be increase by more than the rate of inflation, or progressively it will become worth less. If you have £1,000 stashed under the mattress it will still be £1,000 in say, 30 years’ time, but because of the effects of inflation it is unlikely that this £1,000 will have the same purchasing power as £1,000 today.
The table below compares rates from September 2006 to those in September 2016.
As you can see, in today’s terms money perhaps doesn’t need to work quite as hard as it used to, but as the real rate of return is lower today than it was 10 years ago have our expectations changed to take account of this?
Investors generally regard their investments as a means of generating a return better than that available from cash, as do those approaching retirement, so based on the above figures, ten years ago investments needed to produce a much higher return in order to beat the underlying cash rates available. If the aim today is still to beat cash, returns from investments don’t need to be anywhere near as high as may have been required previously, but expectations often remain the same!
The effects of inflation are far reaching and felt by both individuals and businesses, but not something we can directly influence and control, so it’s important that our financial situations are kept under review to ensure that our aims and objectives for the future remain on track. Contact our Financial Planning Team for advice on 0808 144 5575.
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