In May, annual inflation in the UK as measured by the consumer price index (CPI) rose to 2.5%. This doesn’t sound very much but that doesn’t mean it isn’t a big deal. It’s higher than most analysts expected for the third consecutive month (the consensus forecast was 2.2%) and the highest since 2018.
This level of inflation is also 25% higher than the Bank of England’s target of 2% and six times higher than it was in February. However, this is not a situation that is unique to the UK: in the US, CPI is rising at 5.4% a year.
Central Banks insist rising inflation is transitory and are the base effects of last year’s falling prices working their way out of the system. But it could easily be more. According to Capital Economics, “the rises are bigger than the base arithmetic would suggest which means that genuine price inflation is happening too”.
How far is inflation likely to rise?
The Bank of England reckons inflation will top out at 3%. Capital Economics says 4%. However, both of those expectations look low given how much inflation we can see around us. We can see it in house prices, which recorded a rise of 0.7% in June 2021, following a slightly bigger increase of 1.7% in May. Meanwhile, the annual change of 13.4% is the highest level of growth in nearly 7 years.
The main problem is that increasing inflation could lead to a rise in interest rates and mortgage costs, eroding the value of our assets and reducing future spending power. For that reason alone, it is vital to know how your wealth is distributed and how inflation will affect your holdings. Another thing to bear in mind is that the state pension is linked to inflation, so it impacts how much you are entitled to.
Always be a pragmatic investor in inflationary cycles
If you have a good income a slight rise in the cost of basic goods and services is unlikely to be a great concern. But higher inflation still has financial implications for you, especially if you are retired, so it is important to establish what parts of your outgoings may rise and by how much.
When taking a closer look at how much you spend relative to your liquid wealth, you’ll probably see there are some expenditures that rise at a higher rate than standard inflation, such as school fees, care costs, fuel and in the current climate, even food costs.
In terms of making pragmatic decisions, the assets you hold to provide income in retirement should overall generate a return that at least keeps up with inflation. But it doesn’t mean that you should put all your assets into in higher risk, higher return investments. Getting the right balance between cash and higher growth assets is very important.
Inflation is one risk that needs to be looked at, but a financial plan and investment strategy is based on more than inflation protection. It pulls together a number of risks, objectives, preferences and circumstances that all flow into the overall end result.
How to mitigate the effects of inflation on your portfolio
Inflationary cycles haven’t historically lasted for very long periods of time, which is why you should pay more attention to the short-term when considering investments. Fixed income products that are backed with solid real estate or other tangible assets are ideal in securing a pre-determined return.
Investing through inflationary cycles is not about maximizing your returns; it is about protecting your capital. Although you can always achieve higher rates somewhere in the market, remember returns are always proportionate to risk, which is something you should be actively avoiding.
Ignite Invest has considerable experience of investing through all market cycles, including inflationary. We take time to source opportunities that have the least correlation to inflation and other market forces to allow you to generate quantifiable returns irrespective of the economic climate.
Ignite Invest also participates in all its investment opportunities so as to offer a truly transparent service in difficult times. If you want our help to protect your hard-earned savings with robust, short-term products with low-correlation, contact us today. Our advisers are on-hand to assist.