What is Inflation and How Will it Impact Me?

A November report from the Office for National Statistics (ONS) said that UK inflation had risen to 4.2% in October. This was largely due to the rises in energy and fuels costs. News just broke yesterday that it reached a decade high of 5.1% during the month of November. Similarly, Europe’s statistic office (Eurostat) is reporting that the Euro zone’s rate hit a record of 4.9% in November.

Rising inflation will have repercussions on the average family. Shadow Chancellor Rachel Reeve said that households will face a loss of £20 per week. Therefore, it is imperative for one to have a comprehensive understanding of what inflation is and to also realise how it will manifest in one’s daily life.

What is inflation?

To put it simply, inflation refers to the economic concept of both a decline in money’s purchasing value and an overall increase in prices.

While it is typically viewed under a critical lens, inflation can do both good and bad to an economy. For one, it encourages consumers to buy items and goods sooner, which in turn gives a country’s businesses a financial boost. This has been shown to improve productivity for both businesses and workers.

On the other hand, if the value of money remains the same despite the rise in general prices, it becomes more difficult for consumers to buy as much as they have previously become accustomed to. The rise of everyday items affects the individual because it catalyses a rise in the cost of living. This reduces the individual’s purchasing power. As a result of this, families may find it more difficult to keep within their household budgets.

Thus, while it is true that a little inflation can have a net positive impact, if it becomes increasingly high, it is generally damaging to both individuals and businesses. Additionally, when the rate is unusually high, it is typically bad for those who save. There are less opportunities for returns on investments and savings accounts when low interest rates are combined with rising inflation.

What is causing such high rates?

• Energy is responsible for a large fraction of the current rate. European oil prices are up 48%.

• The world is currently grappling with supply chain issues and global shortages.

• As Europe’s labour market recovers, wages are set to increase. In some countries, the minimum wage is going up, which could escalate pressure on the economy.

• Because the pandemic slowed consumer spending, the demand for goods and services overwhelmed the system once countries began opening back up.

What will happen to my pension?

Inflation can greatly impact retirement savings. This is especially true for those with annuities if the annuity was bought at a fixed rate. If it is to continue rising, those with defined contribution pensions will need to increase their risk in order to keep up with a rising rate. Defined benefit schemes, however, are protected because their income rises in line with inflation. 

You won’t need to worry as much about rising inflation if your funds are being properly managed by a professional, as it is a key consideration for advisers.

How will inflation affect the property market?

The Bank of England will be pushed to raise interest rates if inflation continues to rise. Lenders often call for higher interest rates when inflation soars in order to compensate for any loss in purchasing power and/or value of money that will be paid to them in the future. In turn, mortgages could increase in price and the demand for buying homes may drop.

Will it harm my investments?

When it comes to investing, it is bond owners that may see the biggest effects of inflation. When the rate rises, investors typically sell bonds because it depletes the value of the income. With index-linked bonds, however, the interest paid will rise in congruence with inflation. 

Moderate inflation is not inherently bad for stocks. This is because companies will typically transfer costs to consumers to compensate for their rising input costs. This gives companies a lot of pricing power, and they can usually operate as they normally would. Some businesses, like oil and mining companies, even do quite well as commodity prices rise.

Real estate investment contracts are sometimes linked to inflation. Because of this, their dividends and income rise as inflation rises.

Retailers are usually hit the hardest by periods of rising rates, as they do not have as much room for price increases.

Is inflation here to stay?

Europe is seeing a record inflation rate. Right now, the conversation is revolving around whether Europe’s rising inflation rate can continue to be referred to as “transitory”, or if it is here to stay.

If the European Central Bank (ECB) decides to do away with the term, then this could cause a selloff in peripheral bonds. It may also lead to more stringent financial conditions that have the potential to weaken the economy. However, if the ECB keeps the term, then inflation may become unmanageable. This could then force those more stringent financial conditions later on, which could put an end to any potential economic growth.

It is projected that inflation will continue to rise. Therefore, putting a plan in place is essential. If you would like to speak with an expert about how you can protect your savings, pensions, and investments, contact us today.