Is inflation making a comeback?

The Covid crisis has eclipsed all other financial topics over most of 2020. We may not have completely forgotten Brexit, but it is waiting in the wings rather than on centre stage.

But what about inflation?

Back in January, we were looking at inflation of 1.8%. This was high, compared with a Bank of England Base Rate of 0.5%, but a great deal better than the 3% rate in January 2018. Then came Covid, and inflation tailed off along with economic activity in general.  It fell below 1% in April.

But there are signs that inflation is making a return.

What is inflation?

Inflation is the all too familiar phenomenon of rising prices, something that we are accustomed to in the UK.

There are several possible reasons for inflation.

  • The economy can become overheated, as it did in the 1980s, as the UK experienced rapid economic growth. This led to higher spending, lower saving and an increase in borrowing, and economic growth of 5% a year. It also meant demand outstripped supply.
  • The cost of goods can increase. A third of all goods and raw materials are imported in the UK. When there is a fall in the value of the pound, as there was a after the Brexit vote, those imported goods start to cost more. Inflation peaked at a five year high of 3.1% in November 2017 – well above the UK’s long-run trend rate of 2.5 %.
  • The government – or central banks – may cause inflation by increasing the money supply with quantitative easing. If it is not carefully controlled, too much money can chase too few goods.

Whatever the cause, inflation is a nightmare for savers, who see the real value of their cash savings whittled away. This can make saving not worthwhile – which in turn can make inflation even worse.

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What is happening now?

UK inflation rose by more than expected in October, fuelled by the rising price of clothing and second-hand cars, according to official figures. The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 0.9% in October, up from 0.7% in September. City economists had forecast an inflation rate of 0.6%.

However, it is too early to be sounding warning bells. Despite rising month by month, the rate of inflation remains significantly below the 2% target set by the government for the Bank of England. Threadneedle Street is actually forecasting subdued levels of inflation over the coming months as the UK economy remains under pressure during the second Covid wave.

However, although they may remain stable now, the Bank forecasts prices will start to grow again towards the end of next year as demand recovers.

Should you prepare for inflation?

With vaccines now on the way, the economy could be set for recovery and rapid growth. Economists have warned that a no-deal Brexit could trigger a surge in inflation early next year, if failure to strike an agreement sparks a sell-off in the pound and drives up the cost of imports.

Both factors could mean inflation returning. It could actually be positive, if you have the right investment portfolio, but it means real problems if you have savings, and especially if you rely on them for income.

With that in mind, it might be time to look at your financial plans, and to think about solutions such as investment rather than savings to preserve and grow your wealth.

Successful investment always requires careful planning, That planning will depend on your circumstances and your age – because as the years go by our priorities and financial goals change dramatically.

A Continuum advisor can sit down with you and help you plan your finances for the future, whatever direction inflation and the markets take.

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.

Equity investments do not afford the same capital security as deposit accounts.

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