UK inflation hits its highest level in almost three and a half years. We look at the damage inflation can inflict on your money and investments.
UK inflation has hit its highest level in almost three and half years.
The UK’s Office for National Statistics said yesterday that the consumer prices index (CPI) rose to 2.3% in February, up from 1.8% a month earlier.
It took the rate above the Bank of England’s (BoE) 2% target and may exceed 3% later this year.
Rising inflation increases the pressure for interest rate rises. It is also a threat to the value of money. The chart below explains this.
Inflation erodes the value of savings over time as it reduces spending power. This means the same £1 in a year buys you less than it would do today. Inflation can explain why a Mars bar costs 60p today, but cost 26p in 1990.
The chart shows how the real value of £100 can deteriorate over time, based on two rates of inflation – 1% and 5%.
With a consistent 1% inflation rate for 20 years, £100 would shrink to £82. But make it a rate of 5% and £100 would be worth a mere £36 in real terms after 20 years.
In August 2016 CPI inflation was at just 0.6%, underlining how rapidly price pressure has built in recent months.
Azad Zangana, UK and European Economist at Schroders, said: “Inflation has been rising steadily for some time, mainly due to the negative impact of the recent fall in global energy prices dropping out of the annual comparison.
“However, the impact from the fall in sterling is now also feeding into consumer prices, which is set to squeeze household finances over the course of this year.
"We forecast inflation to rise through 3% in the coming months, before peaking around the end of the summer, and then steadily coming down to around 2% over 2018.
- Why stock markets rise when currencies fall - explained in two charts
- The road to Brexit: what next for shares and property?
“For the BoE, the latest figures will be disappointing. Inflation is likely to overshoot the Bank’s forecast and could persuade rate-setters to consider raising interest rates later this year.
"Indeed, outgoing Monetary Policy Committee member Kristin Forbes voted to raise interest rates at the last meeting, and could have more support over the coming months.
“We expect the Bank to hold fire for now as the rise in inflation is not being matched by higher wage inflation. As a result, the real disposable income of households is falling, which should reduce demand in the economy and therefore inflation in time.
"We doubt the BoE would want to raise interest rates at a time when household finances are being squeezed.”
The potential effect on stock markets
Equities can provide some shelter at times of inflation: stock prices may rise if the companies can pass on price hikes to customers. These price increases may allow companies to raise dividend payments more rapidly.
Inflation can be more helpful to certain stock market sectors.
Marcus Brookes, Head of Multi-Manager at Schroders, had expected a sharp pick-up in inflation a year ago and began preparing. He said: “Our portfolios have benefited from rising inflation, as we predicted. We invested in areas that typically benefit from a generalised rise in prices, such as commodities, financials and cyclical companies – those that are more profitable as the economy picks up.”
Cyclical stocks are those most sensitive to swings in the economy.
Inflation is also rising in Europe. James Sym, European Equities Fund Manager, last month said there was evidence that a pick-up in inflation was “becoming embedded and not just the commodity-driven spike that many commentators expect”.
He expected European telecoms, insurance and consumer stocks to benefit. Read the full report here: Which sectors could benefit as inflation heats up?
Important Information: The views and opinions contained herein are those of Ben Arnold, Investment Writer, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.