What’s happening with inflation?
After years of very low and steady inflation, prices have started edging higher. In the UK, inflation reached 2.1% in May, with the Bank of England (BoE) warning it could hit 3% later this year.
The BoE sees the price rises as a temporary blip caused by Covid-related demand/supply issues. On that basis, the Bank’s policy committee members voted almost unanimously to leave interest rates unchanged at 0.1% at its last policy meeting.
Others, including the US Federal Reserve (Fed), take a less sanguine view and fear higher inflation may become entrenched. That could herald sooner-than-expected interest rate rises as central banks seek to curb consumer spending. After US inflation reached 5% in May, the Fed brought forward the date it expects to start raising interest rates to 2023.
Why is inflation rising?
The causes of higher inflation are largely Covid-related. The easing of lockdowns has boosted consumer confidence and unleashed pent-up demand. At the same time, bottlenecks in production and distribution are squeezing supplies – from building materials to foodstuffs. This supply/demand imbalance is forcing up prices.
Why does inflation matter to savers and investors?
Investors and savers often underestimate the damaging effects of inflation on their wealth. People on fixed incomes – such as those whose pensions aren’t inflation-linked, or workers on a static wage – are especially vulnerable to the effects of inflation.
As living costs rise, your money doesn’t go so far. To give an example, if prices rose 5% every year for the next 10 years, £100 in your pocket today would be worth only £55.
Pension savers need to think about what their savings might be worth during retirement – often a long time into the future. Inflation can make the difference between an enjoyable retirement and a frugal, worrisome one.
That’s why you should consider mitigating the effects of inflation by investing at least some of your money in assets that aim to offer above-inflation returns.
Does rising inflation mean interest rates will rise too?
Most central banks have a target level of inflation – usually 2%. If inflation persistently exceeds that level, the central bank will consider raising interest rates to curb consumer demand.
Arguably, we can expect inflation to settle back to lower levels once the post-pandemic surge in demand has been sated and supply chains are smoothed out. But even so, with the global economy poised for a strong rebound, most central banks are keen to get back to ‘normal’ monetary conditions. So rock-bottom interest rates can’t last forever.
But, while rising interest rates could be good news for savers, even if rates go up, they’re almost certain to be less than the current rate of consumer price inflation. That means the buying power of your money will be falling.
Where can I invest to protect against inflation?
Bonds and other assets that pay a fixed income and/or a fixed investment return are especially vulnerable to inflation. Bonds become less valuable as inflation and interest rates rise, reflected in falling bond prices and rising yields.
Conversely, shares are generally a good investment during periods of modest inflation. A company’s fortunes typically track consumer demand and economic growth. If demand is strong, companies can raise prices, boosting the profits from which they pay dividends to their shareholders.
In fact, historically shares have done well during periods of inflation. For example, data from Barclays’ Equity Gilt Study showed that over a period of 118 years, shares delivered 5.2% on average each year compared with 0.7% for cash. That’s after taking account of inflation*. Only if inflation reaches very high levels is it likely to become a problem for investors in shares.
Remember though that past performance is not necessarily a guide to future performance. Also, having your money in cash is generally regarded as secure, whereas investing your money isn’t. This is because the value of all investments can go down as well as up, and you could get back less than you paid in.
Besides shares, there are other assets with a track record of doing well during times of moderate inflation. These include infrastructure assets, where income streams increase as demand grows and the assets mature. Inflation can be good for real estate too, through capital appreciation of the property and/or rising rental income. Likewise, gold and other commodities can be useful stores of value to hedge against inflation.
How will inflation affect the value of 1825 Portfolios?
The 1825 Portfolios are able to invest in an unusually broad mix of assets and geographies – not just traditional equities and bonds but also infrastructure, currencies, money markets and other assets across world markets. Depending on prevailing economic and market conditions, the portfolio managers will allocate to the assets they believe will deliver the best returns for your preferred level of risk.
For example, if the managers believe higher inflation is here to stay, they may consider reducing the allocation to government bonds and increasing exposure to infrastructure. In this way, they can aim to mitigate – and even benefit from – the effects of rising inflation.
Do I need to take any action?
If you’re invested in the 1825 Portfolios, you can rest assured the managers are looking after your investments, aiming to get the very best returns for the level of risk you’ve chosen. But if you have any questions or concerns about your investments, and the potential impact of inflation on them, please contact your 1825 financial planner, who’ll be happy to help.
*Source: Barclays, Courtiers Asset Management, Bloomberg.
Please remember that the value of investments can fall as well as rise and you could get back less than you paid in. The information in this blog should not be regarded as financial advice. All information is based on our understanding in July 2021.