Inflation has become a very hot topic in financial circles. Low interest rates and quantitative easing, the process by which central banks pump new money into the economy may well be vital to getting the economy running again – but they can both also stimulate inflation.
At Continuum we are looking at how inflation could affect you – and whether you should worry.
Is inflation getting worse?
Inflation is simply the age-old phenomenon of rising prices. It can happen for a number of reasons, butwhatever the underlying cause, inflation can be a problem, because it affects what you can buy for your money. When there is inflation, money doesn’t go as far. When your wages don’t keep up with inflation, your purchasing power is reduced and your standard of living falls.
Now, as the global economy emerges from lockdown, pent-up demand and supply chain bottlenecks mean demand exceeds supply in many sectors. Scarcity leads to price increases.
Inflation is measured as a percentage increase or decrease in prices over time, and in the first two decades of this century, it averaged around 2% a year.
Economic theorists believe some inflation is necessary. 2% is the ‘Dorrance number’, named after Graeme Dorrance, Chief of the Financial Studies Division at the International Monetary Fund (IMF) who in 1965, promoted it as the optimum inflation level, for encouraging growth.
That 2% may not sound a lot, but when inflation is sustained, the effects are multiplied. 2% annual inflation 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 might not be a problem if your income rises in line with inflation. But if it does not, inflation can become very painful.
Who suffers from inflation?
People on a fixed income. A pension annuity offering 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 it buys much less.
Savers. The interest your money earns in a savings account is no longer enough to keep pace with inflation. Your savings fall in real value, and when you draw out your cash it will buy less than it did when you put it away.
The state pension is rising in April but it is based on September’s 3.1% inflation figure – which is already out of date. That means if inflation remains as high as it is now, the £5.50-a-week pension rise will be outstripped by living costs.
Who benefits from inflation?
Homeowners. The value of homes increases with house price inflation, potentially turning a small home into a big asset.
Mortgage borrowers. Anyone with a mortgage, and especially a fixed-rate mortgage benefits from inflation, as it will reduce the real value of their debt,
Borrowers. Individuals and businesses find it easier to pay back historic loans if the value of money falls.
What is inflation really doing?
Back in May the UK inflation passed the 2% mark as recovery started to gain traction.
Many observers think this is just the beginning. A month ago, the Office for Budget Responsibility forecast inflation would reach 5%. Economists at Citi now expect the RPI measure of inflation to run at around 6% next year for months, and peak at 7.1% next May.
Figures released in mid-November by the office for national statistics suggested that the cost of living has already surged by 4.2% in the 12 months to October, the highest rate in almost 10 years. This is mainly due to higher fuel and energy prices but the cost of second-hand cars and eating out also rose. The costs of goods produced by factories and the price of raw materials have also risen substantially and are now at their highest rates for at least 10 years.
So what can you do?
Obviously, as an individual there is nothing you can do to resist the tide of inflation. But you should probably factor it into your financial planning. That means looking at the targets you set for your pension and other savings, and possibly setting them higher.
Fortunately, although inflation can eat into the value of cash savings, it can support a rise in the value of investments.
Becoming an investor
Whether you are worried about inflation or simply want to make the most of your money, investment could be the answer. See how we can help you become an investor.
Becoming an investor is easier than you might think 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.
Don’t let inflation become a problem. Call us at Continuum 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.