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November 29, 2022

Investing and inflation: what does it all mean?

Our analysts give you some insight into how they see investments behave in times of increased inflation and help set your expectations for the months ahead.

What does inflation mean for my savings and investments? 

You can’t have escaped all the noise about inflation in the news recently since the increase in price is impacting. Inflation is measured by the Consumer Prices Index (CPI) which looks at price increases (inflation) across a broad sample of popular goods and services. The UK CPI was 11.1% in October, compared with the same time a year ago, an estimated 41-year high.1

One part of this is energy costs which have risen sharply following Russia’s invasion of Ukraine. This is partly due to sanctions imposed on Russia, a major oil producer, by nations which condemn the hostilities. The war has also pushed up prices for grain and other goods sourced from the region.

Will raising interest rates bring down inflation?

Central Banks of developed countries have embarked on a path of interest rate rises that they hope will tackle this increase in inflation. We have seen in the UK; the base rate could move from close to zero to a peak of 4-5%. 2

The thought is that by increasing interest rates, people will save their money rather than spend it which will reduce demand and hopefully reduce prices. But it’s a fine line between achieving this and tipping the economy into recession (that’s when it shrinks instead of growing). 

What’s more, todays’ inflation has been largely caused by supply problems (such as the Ukrainian war) rather than too much demand. This situation creates a risk of ‘stagflation’ which means both low growth and high inflation. The Bank of England is currently forecasting a UK recession that will not be deep but could last up to 2 years.3   

Interestingly the stock markets in the USA have recovered recently, following tentative signs that inflation may have passed its peak over there.4 So, if a downward trend in inflation is indeed established, interest rates may not go up as far as feared. 

The UK may not yet have reached this stage, but the US markets’ response gives us grounds for optimism. In his Autumn statement the Chancellor, Jeremy Hunt, said he expects inflation to fall sharply from mid-2023.5

How does this affect my investments?

What’s happening in the economy does of course influence the market performance and explains why it has been disappointing this year. That said, share price moves do not usually mirror economic trends as markets tend to be forward looking and react in advance to what they think lies ahead.

So, by the time the worst of the official economic data materialises, share prices may be moving up in anticipation of recovery. Volatility in stock markets is part and parcel of investing so it’s important to remember that stocks and shares investments are for the long term.

What does it mean for returns on cash and bonds?

Whilst interest rates on cash deposits which you keep in a bank or building society are improving, they are still well below the rate of inflation. This means the value of what your money can buy is reduced.  Although your capital will (barring exceptional circumstances) be safe, it cannot keep up with the rising prices of goods and services. 

Bonds (fixed income) have not lived up to their reputation for providing balance to a portfolio when shares (equities) fall. This is because their interest rates (fixed at issue) became less appealing, as higher inflation reduces their real returns (after inflation). 

That is why we see bond prices dropping until their yields start to attract investors again (when prices fall, yield rise). However, unlike cash, Bonds do offer the prospect of some capital growth if bought at the right time. 

Which investments might offer some protection against inflation?

Equities (shares in companies) may offer better prospects for long term growth since a company may grow in value and you may also receive dividends. If you reinvest any income, you get the benefit of what is called compounding, or put simply ‘growth on growth’. When the economic outlook is challenging, defensive sectors like food, healthcare, and utilities (essentials we can’t easily do without) may hold up better. It is also important to look for companies with pricing power, perhaps because they are market leaders, which can pass on cost increases and protect their profit margins. 

It's key to have a plan

The cost-of-living crisis is putting a strain on many peoples' personal finances so it may help to set out a budget for the present and a plan for your future.  Even putting aside relatively small sums towards your most important goals   can build into a worthwhile sum over the long term.

Whilst leaving your life savings in cash risks it being eaten away by inflation, we all need a buffer fund, especially in times of rising prices and high inflation, to help with any unexpected expenses. If you do have to cut back on savings or investments try to resume them  when you can. 

At times of heightened volatility in markets, human psychology tends to affect our emotions and actions. It can be difficult to remain positive when there is so much negative news, and it is human nature to panic when markets fall. However, timing the market is nearly impossible, even for professionals so consider whether it may be better to stay invested and drip feed money in regularly. The best thing to do is keep calm!





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Please remember that when investing, making money is not guaranteed and your capital is at risk. The value of your fund can go down as well as up. Tax treatment depends on an individual’s circumstances and may be subject to change. 

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