Inflation – What’s happening?

Understanding inflation is an important factor when it comes to your financial success. If you do not factor inflation in when deciding where to put your money – whether that’s savings accounts or investing – you could find your wealth shrinks over the years.

The current causes of higher inflation are largely COVID-related.

Lockdowns have eased which has boosted consumer confidence and unleashed pent-up demand. The supply and demand imbalance has forced up some prices – from building materials to foodstuffs. The rate of inflation is the change in prices for goods and services over time.

Some investors and savers may underestimate the damaging effects of inflation on their wealth.

People on fixed incomes, such as those whose pensions are not inflation-linked or workers on a static wage – are especially vulnerable to the effects of inflation. As living costs rise, your money does not go so far.

Pension savers need to think about what their savings might be worth during retirement. Inflation can make the difference between an enjoyable retirement and a frugal, worrisome one.

What do the Banks think?

The Bank of England’s departing chief economist Andy Haldane has warned that inflation is “rising fast”. He believes it could reach nearly 4% this year. That is well above the Bank’s target rate of 2%. This was exceeded in May, when inflation reached 2.1%.

The Bank’s Monetary Policy Committee is slightly less hawkish. He expects inflation to go above 3% “for a temporary period.” The Resolution Foundation sides with Mr Haldane. He argues that as the economy opens up and consumers start to spend the savings they accumulated during lockdown, inflation will be driven up.

Bonds and Shares

Bonds and other assets that pay a fixed income and/or a fixed investment return are especially vulnerable to inflation. This is because Bonds become less valuable as inflation and interest rates rise. This is 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.

Infrastructure Assets

This is where income streams increase as demand grows and the assets mature. Likewise, gold and other commodities can be useful stores of value to hedge against inflation. So the good news is that it is possible to get an inflation-beating return on your savings. This is because there are different investment opportunities. However, these involve taking on a little more risk than with a cash savings account.