You may have heard news that UK inflation is on the rise. The Bank of England (BoE) sets the target rate at 2%, yet the most recent figures show that prices have risen in the UK economy by 4.2% over the last 12 months. Indeed, the BoE projects that inflation could even reach 5% in April 2022; the highest rate since 2011. Yet why is the overall cost of goods and services rising so much in the UK, and what does this mean for your finances? Is there a way to protect your wealth against the harmful aspects of inflation – particularly savings and investments? Below, our team at Vesta Wealth explores these questions in more detail.
Why are prices going up?
UK inflation has held fairly steady for some time now – either at, or under, the BoE’s 2% target. What has changed to make prices rise above this? One factor is the rise in oil and gas prices in recent months, which has led to higher costs for car fuel and household energy bills. Another factor is the shortage in supply for in-demand goods. At the moment, there is a global shortage of microchips which is leading car manufacturers to struggle to produce new models which rely on them. As such, demand for second-hand cars in the UK has surged as consumers look to replace their existing vehicles.
Two other possible reasons could lie behind the rise in inflation. One is that pent-up demand for goods and services during the height of the Covid-19 pandemic has been unleashed with the lifting of national lockdowns. For instance, retail and restaurant prices have risen as in-store sales have climbed back up. Another is that there is a shortage of workers in sectors such as hotels, bars and restaurants. Again, where supply struggles to meet demand, a rise in prices generally ensues.
The impact on finances
It is important to stress that, even though higher inflation represents higher prices in the UK economy as a whole, it does not mean that all prices are set to rise. Above, we have mentioned some specific sectors which have driven the Consumer Price Index (CPI) up such as energy, computer chips and automobiles. Therefore, certain areas where supply still outstrips demand may witness price stability as we enter 2022 – perhaps even a price drop. However, the rise in energy prices does, unfortunately, tend to have a wide impact.
Supermarkets, for instance, rely on lorries which deliver goods to each location. These rely on drivers (in short supply) and oil (running at multi-year highs) to fuel the engines. Companies that rely on vehicles, such as car rental and aviation, must pay a higher cost for oil and so pass this on to customers to protect their profits. As such, although UK households may find that certain aspects of their monthly expenses hold fairly steady in 2022 (e.g. annual digital subscriptions), it would be wise to prepare your budget for a rise in costs for goods and services such as petrol, food and energy in the months ahead.
Inflation and wealth
A less-known aspect of inflation is that it is the silent killer of savings and investments. The higher the rate of inflation, the more it erodes the spending power of your wealth. For instance, suppose your bank account pays a 0.67% interest rate, allowing you to generate a return of £67 on your £10,000 held in cash. If the BoE achieves its inflation target of 2%, then, in real terms, your savings have fallen in value. This is because your money cannot buy as many goods and services as it could before.
For this reason, it is important to ensure that your wealth growth/preservation strategy takes into account inflation. If you want to generate an average “real return” of 3% per year over, say, 10 years, then your investments will need to perform much better if inflation averages at 4% in this time period. In such a scenario, this likely means turning to higher risk investments which offer a higher potential return, such as shares. For some people who would prefer to take on lower investment risk, this may conflict with their risk appetite. In which case, it is important to consider discussing your strategy and goals with your financial planner.
Another option for investors might be to invest in sectors or industries which are expected to fare reasonably well – even thrive – during periods of higher inflation. Naturally, energy (e.g. oil and gas) can benefit within such an environment; as can consumer staples such as clothing, food and personal products – anything people rely on. There is also the option of investing in inflation-linked assets such as those issued by the UK, US and other sovereign governments. These help to protect the value of your investment when inflation continues to rise. However, they are vulnerable to rises in interest rates. If a period of deflation ensues, the value of your investment will not be protected.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.