My local petrol station forecourt is not a typical forum for debate. But on my recent trip, I witnessed audible disbelief at the rising price of fuel and difficulty comprehending the reasons behind it, and all the publicised inflation and “cost-of-living crisis”.
As is often true with financial matters, it can sound like a foreign language jargon and acronyms – so whilst avoiding any politics, let’s break it down a little.
What is inflation? Simply put, it is a rise in the overall level of prices, over a given period of time, for the goods and services consumed by households.
To measure it, the Office for National Statistics (ONS) builds a “basket” of over 700 commonly purchased items. The contents are regularly updated and just saw meat-free sausages added and suits and doughnuts removed – explained by an increase in home working. The annual price change of these goods is called the ‘consumer price index (CPI).
Another but less frequently used measure is the Retail Prices Index (RPI) which, unlike CPI, includes housing costs (such as mortgage payments).
What causes inflation? Tricky to answer in a few words, but inflation arises mainly because demand outstrips supply. Following Covid, people naturally wanted to start spending their money again, however, businesses struggled to get manufacturing restarted and compounded by supply chain issues, couldn’t get goods to customers fast enough. Russia’s invasion of Ukraine has led to additional price increases in energy and various foods and China’s ‘Zero Covid’ policy and strict lockdowns also made it harder to import some goods, pushing up prices further.
How to control it?
The Bank of England uses monetary policy to influence how much money is available
in the economy and the cost of borrowing it. It does this through controlling interest rates via the ‘base rate’. Higher interest rates make it more expensive to borrow, which encourages saving and less spending. This means prices will tend to rise more slowly, which lowers the rate of inflation. Lowering interest rates has the opposite effect.
So, what does this mean for us?
Higher interest rates mean paying more interest on debt but also getting more on savings. However, a savings account with an interest rate lower than the annual inflation rate means the interest rate is actually negative in “real” terms and the purchasing power of your money is eroding. Also, unless your income keeps pace with inflation, you’ll find yourself less well off.
How worried should we really be and what can be done?
The ‘brains’ at the Bank of England and the ONS predict continued rising inflation in the near term, peaking at the end of 2022.
However, within twelve months of this, they forecast levels returning to the long-term government target of 2%. This would be reassuring if not for the fact that these predictions have been revised several times recently after inflation rose faster and higher than expected. The graph below shows how often they actually hit their 2% target…..
Here at Strategic Solutions, we aren’t in the game of making predictions, but we can position our client’s portfolios to best cope with all possible scenarios.
When building plans to achieve our client’s financial goals, we take a long-term view, be that for someone starting their career, or someone on the cusp of a long and hopefully happy retirement.
So, should our plans now factor in an inflation rate of 9.1% (current CPI) or even higher? For now, the answer is no, as for our long-term plans we use long-term trends. It takes multiple years of sustained higher inflation to increase the rolling 30-year average our views are based upon. This expected ‘short-term’ period of higher inflation will have a relatively modest effect on long-term trends and therefore our long-term thinking.
Not all investment types are impacted the same during rising inflation, and some can even benefit from it. This highlights
the importance of diversification. Having the right mix and adjusting at the right time can ensure we can take the sting out of this difficult time.
This information doesn’t make the cost of shopping or a tank of petrol any easier to afford today, however it should mean the longer-term outlook isn’t as doom nor gloom as the headlines may suggest. In the meantime, having a financial plan, thinking longer term and making appropriate adjustments only when necessary, should provide a little less to worry about. If you have friends or family who you think may benefit from our help, please do not hesitate to put them in touch with us.
Email us at email@example.com to find out more.