Rising inflation March 2022

The lowdown on inflation and what it means for your savings and investments. And how you can help protect your wealth during periods of higher inflation.

What’s happening with inflation?

After years of very low and steady inflation, prices are currently moving higher rapidly. In the UK, this is most obvious in the rising cost of energy and fuel. And it doesn’t look like inflationary pressures will ease any time soon because of the crisis in Ukraine. Oil and gas prices are likely to remain higher for much longer as sanctions against Russia, one of the world’s largest oil and gas exporters, take effect. Food prices are likely to rise too because Russia and Ukraine are big grain suppliers.

For savers, or those in retirement, it’s important to manage savings to help mitigate the impact of inflation. To do this, your money needs to grow in value. Which is where investments can be so valuable as they give your money more opportunity to grow in value over the longer term than cash savings, and importantly to keep pace with, or even beat inflation.

Key facts on inflation and its effects

Inflation measures how much prices have gone up over time. The average increase in prices from one year to the next is known as the inflation rate.

Slow and steady rising inflation is viewed as a sign of a healthy economy.

Where it can have a negative impact is where prices rise more rapidly or move around a lot, often because of an imbalance in supply/demand for products and services. Any fixed income that isn’t growing in line with the rising cost of living means the money in your pocket can’t buy as much.

1. 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.

2. 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, they’ll often consider raising interest rates to curb consumer demand.

The Bank of England has now raised interest rates three times since December – to 0.25%, then to 0.5% and most recently to 0.75%, with the aim of bringing down inflation.

But while the rising interest rates could be good news for savers, they’re still less than the current rate of consumer price inflation. That means the buying power of your money will be falling.

Tips to help mitigate the impact of inflation

1. Consider whether cash is the best place for your savings

Although the face value of cash savings doesn’t change, cash is particularly vulnerable to inflation. This is because it has limited opportunity to keep pace with the rising cost of living. If you have cash savings earning 1% interest a year and inflation is at 5%, cash is effectively losing 4% in value.

An easy-to-access ‘emergency’ fund is an incredibly valuable financial resource. But if you don’t need instant access to your money, it’s worth considering investing it. This gives it the opportunity for growth to keep pace with or even beat inflation.

2. Think about having some investments that aim to offer above-inflation returns

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.

Shares on the other hand are generally considered 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.

Only if inflation reaches very high levels is it likely to become a problem for investors in shares.

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.

Remember though that past performance isn’t 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.