Low interest rates and quantitative easing, the process by which central banks pump new money into the economy are key to getting the global economy back up and running after it ground to a halt during the pandemic.
The problem is that as well as economic activity they can both also stimulate inflation.
As the country unlocks we are looking at how ramping up inflation could drive down your personal finances – and why it could also mean an exciting opportunity.
Why inflation matters to you
Inflation is the familiar phenomenon of rising prices, caused by demand exceeding supply or rising external costs. Covid and lockdown reduced economic activity, eliminating the inflationary pressures that were becoming a worry 18 months ago. The cost of some goods fell early in the pandemic amid a collapse in demand.
Inflation is a key measure of financial well-being because it affects what you can buy for your money. If there is inflation, money doesn’t go as far. It is expressed as a percentage increase or decrease in prices over time. If wages don’t keep up with inflation, purchasing power and the standard of living falls.
Now, as the global economy emerges from lockdown, pent-up demand and supply chain bottlenecks are already creating severe price pressures. There are already shortages in some key sectors such as semiconductors. Scarcity inevitably means price increases.
It looks as though the process of inflation has already begun, When May inflation data was released the figures were higher than expected. US inflation was at its highest level for 13 years. In the UK inflation has passed the 2% mark and may be heading higher.
Inflation may be the price we will have to pay for the recovery we need. But when it comes to your own finances, you need to ask whether you can afford it.
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What does inflation mean to you?
In practical terms, inflation means rising prices. In the first two decades of this century, inflation averaged around 2% a year, and on occasions passed 3%. This may not sound a lot, but inflation cumulates or ‘compounds’ over time. That 2% a year means that prices in 2021 are nearly 50% higher than in 2000. An item that cost £10 in 2000 would cost around £15 in 2021.
This is manageable if your income rises in line with inflation. If your income is fixed, because you live on a pension annuity for example, it means that what seemed a generous retirement income when you stopped work can feel much smaller twenty years later. The amount coming in each month is the same, but in practical terms, it buys much less.
Inflation is also a problem if you are a saver. Putting cash away in a savings account for future use used to be prudent. When interest rates are low, as they are now, it can start to look positively profligate. The interest your money earns is no longer enough to keep pace with inflation and your savings fall in real value over time. When the time comes to draw out your cash it will buy much less than it did when you put it away.
Of course, where there are losers, there are also winners. Anyone who owns their own home may see their wealth increase as house price inflation goes to work. Anyone with a mortgage, and especially a fixed-rate mortgage benefits from inflation, as it will effectively reduce their debt. Businesses will find it easier to pay back historic loans if the value of money falls.
The government may benefit from inflation as it eats away at the huge deficit accumulated in up propping up the economy during the lockdown and increases tax revenues.
But there is a way to make inflation work for you
Inflation may be whittling away at the value of cash savings, but it can act to support the rise in value of investments. Investments, where your money is used to buy something rather than kept as cash savings will act to preserve and hopefully increase its real value.
Becoming an investor is easier than you might think, and you don’t need to be a financial expert especially with help from the Continuum team. We can help you find tax-efficient funds such as Stock and Shares ISAs where your money will be invested by expert managers with the aim of providing the growth or the income you need. You can even pay in monthly and withdraw funds as you need them.
Inflation might still eat into the value of cash, but it could make starting investment all the more rewarding.
To find out more, simply contact us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action
The value of investments can fall as well as rise and you may get back less than you invested.
