Inflation is back – should you be worried?

Inflation has been off the agenda for investors for years, but prices are rising again – and it could have implications for your finances.

Inflation has been low by historical standards for much of the past decade, with price growth falling particularly sharply over the past three years. Never the easiest factor to track when it comes to your finances – a situation not helped by the amount of measures for inflation which exist – inflation has nonetheless been muted for the past few years. Using the Government’s preferred method of calculating inflation – known as CPIH – we can see that inflation has been below its official target of 2% since July 2019.

What is CPIH

CPIH stands for The Consumer Prices Index including Owner Occupiers’ Housing and covers the cost of a list of everyday items consumers buy or use, including housing costs. Between July 2019, when it stood at 2%, CPIH has plunged as low as 0.5% in the depths of the pandemic last August, before recovering as the economy unlocked. It currently stands at 1% as of March, with the reading for April due out later this month. Clearly this is some way off the Bank of England’s own target of 2%, but the important thing to remember with inflation is the trajectory, not the absolute number. This was alluded to at the latest Bank of England meeting when Andrew Bailey, the governor of the Bank and head of the committee which monitors inflation, said inflation could be “a bit bumpy this year.”

Indeed, the central projection from the Bank is that, as the vaccine programme continues and the economy unlocks more, it should mean the CPIH figure jumps above 2% towards the end of this year. There is also the ever-present risk that it goes higher than forecast, with factors such as rising commodity prices and demand for goods and services also having the potential to exceed forecasts and push up the overall inflation number.

Should you worry about rising inflation?

Inflation is bad for some of your investments, in particular cash. The value of cash is eroded over time by inflation, so a pound today buys you substantially less than it did 20 years ago, for example. For investors sitting on large amounts of cash, rising inflation is problematic at this point in time because interest rates – and therefore the interest the bank pays you for leaving your money in cash – are at record lows. The Bank of England was forced to cut rates to 0.1% in the UK last year in response to the pandemic, and it has yet to raise them from this level. With inflation currently at 1%, it means the value of any cash you may have in the bank is being eroded every year, unless it is in a bank account paying more than 1%.

For investments too, rising inflation has implications. Some investments, like commodities such as oil, can protect portfolios from rising inflation, as they often rise in tandem. Investments such as bonds, on the other hand, suffer because they pay holders a fixed amount of interest every year, and if inflation rises it can often leave these bonds paying an income that is below the inflation rate.

What can you do about it?

As with all investments, including cash, investors should regularly review their holdings. If inflation is rising, there are a number of options to counter its damaging effects on your wealth, including investing in equities, commodities, and some inflation-linked investments which track the inflation rate.

However, as always, if you have any concerns or queries the best course of action is to get in touch with your adviser.