Article

Inflation hits 9.1% - what can consumers and investors do?

The cost of living continues to rise, but why is this and what can consumers and investors do?

| 10 min read

The rate of UK inflation rose to a fresh 40-year high of 9.1% in May, according to the latest figures from the Office for National Statistics. It represents a slight increase on the 9.0% figure of the previous month, which was driven upwards by the rise in the energy price cap.

Why is inflation so high?

Starting in March 2020, central banks and governments around the world pumped extra money into the economy to support individuals and businesses through the Covid-19 pandemic and to stave off a damaging downturn. By March 2022 US money growth was up 36% over two years, and in Europe, it was 17%. Extra money circulating in the system tends to drive up prices, all else being equal.

In addition, global supply chains were disrupted by the pandemic, and some Chinese cities are still currently in restricted conditions. This has constrained the availability of goods in some areas and increased prices as companies have scrambled to build more resilient, but frequently more expensive, supply lines.

On top of these factors, the Russian invasion of Ukraine has driven up the prices of many key resources. The sanctions on the former and curtailed exports of the latter have restricted the world’s supply of oil and gas, as well as certain agricultural products and metals. Prices have risen for these key commodities, and this impacts the prices of all sorts of goods and services the world over. For instance, transport, chemicals and fertiliser all cost more if the cost of energy rises.

At the same time, the world is seeking to transition away from predominantly fossil-fuel-powered energy production to a more sustainable mix, something that requires a significant quantity of energy, as well as a variety of various metals, to achieve. Yet traditional energy production and mining are lacking in production capacity and have their own supply chain issues.

Finally, the employment market is tight with plenty of jobs available and a general lack of personnel to fill them. If these conditions persist, it could mean wages rise to attract and retain workers, which in turn could drive prices higher and risk a self-reinforcing spiral.

What can consumers do?

The recent bout of rising prices is a distinct change from what consumers have been used to. In recent memory, inflation has been low in most developed economies. Now, a much higher level is being experienced across most of the world as prices of food, fuel and many other items that make up regular expenditure are rising much faster.

We expect this will moderate in the months ahead as demand for goods and services is reduced – thanks to higher prices which essentially act as a tax – and as supply chains are patched up. If price rises are on a lower trajectory the headline inflation numbers fall on a mathematical base owing to measurements being taken from a higher base.

What we don’t know is how long it will take for this balancing out to take. As it stands, a further increase in the energy price cap in the autumn will add to UK inflation, though there is a more positive sign that some key commodity prices have started to drop back over the past month. Whatever happens, it is worth taking action to boost your finances.

Come face to face with your finances

Many of us dread sitting down and going through our finances, but without doing so it can be difficult to keep up with how much is coming in and out of our accounts. Creating a budget sheet that lists everything in one place will also help you spot where you can cut back.

At a time when we have so many subscriptions and financial products, it can be hard to keep track. Going through what contracts you have in place will help you spot whether you are overspending, where you can economise or get a better deal and check that you’re getting what you’re paying for. You may find more competitive offers by shopping around and comparing rates on utilities, car insurance, and mobile phone contracts. Consumers can also guard against rising prices by fixing certain outgoings, such as energy bills, loans and mortgages.

Make the most of tax-efficient savings

Saving, particularly for your pension, may not be something you are thinking too hard about right now, but if you don’t you could be missing out, and it could harm your longer-term future if you cut back in this area. Most people can receive extra money every time they pay into your pension pot through tax relief, and if you are eligible for a workplace pension your employer will make valuable contributions to your pot.

Don’t worry in silence

If you have concerns about your finances – whether it is income-related or savings and investments – you won’t be alone, so don’t suffer in silence. There’s help out there, whether it’s from your employer, financial adviser, or charities. Speaking to someone will help alleviate some of the worries.

What can investors do?

How widespread the inflationary forces are and how long they will linger is the major issue pre-occupying investors. For much of last year, central banks dismissed inflation as ‘transitory’, but they are now much more concerned that inflation could be becoming embedded – and more serious about combating it through higher interest rates.

This has been hampering bonds, investments representing government or company debt that pay a (usually) fixed amount of income. As interest rates rise, the income stream from bonds appears less attractive and investors demand a lower price to buy them.

Falls in bond markets has spilt over into share markets as the value of profits streams from companies has been similarly seen in a new light. Future profits are worth less in today’s terms if inflation is higher. There are also greater pressures on companies in terms of higher commodity and finished goods prices, and potentially higher wage bills. With consumers and businesses in a less healthy position the possibility of recession – a contraction in economic activity – is a distinct possibility as the central bank ‘medicine’ of higher interest rates gives the patient, the global economy, some nasty side effects.

This makes the investing environment difficult. On the one hand, investors are trying to hedge against, or even benefit from, higher inflation. On the other, a collapse in demand may lie ahead as higher prices take their toll. While better times will return over time, investors do need to be prepared for choppy markets as these inflation and recession concerns ebb and flow.

Diversify

As always, diversification is the most effective strategy an investor has when faced with uncertainty. Focusing too much on one type of company or one sector will tend to increase volatility across your portfolio. As investment great Sir John Templeton put it, “The only investors that don’t need to diversify are those that are right 100% of the time”.

It’s best to prepare for different outcomes and spread your money around so you are not reliant on a single company or type of business. To help combat inflation specifically, investors may benefit from exposure to ‘real assets’; commodities such as gold, property and infrastructure.

Companies that are able to control their input costs, or have the ability to pass on costs to consumers to help preserve profit margins, are likely to fare better in an inflationary environment. Businesses that sell into markets where spending is more necessary than optional are also better placed.

Don’t time the market or overreact

Trying the time the market is to be avoided as it can make a bad situation worse. Large falls can be followed by large rises, so you risk losing on both sides – selling when prices are depressed and not buying in until they have moved higher. Being out of the market also means you are no longer collecting – and potentially reinvesting – any income your investments are paying.

Daily monitoring during a falling market can result in an over-emotional reaction and make rational decisions difficult. If you have a well-diversified portfolio of collective investments such as unit trusts and investment trusts, as well as a strategy you are happy with, then a less regular (for instance monthly) check should be sufficient.

Keep the long term in mind

Shares remain the best investment over the long term, but the price investors pay for this is short-term volatility, which can at times be considerable. If you have been keeping some cash in reserve, market weakness could be an opportunity to consider investments that you previously thought were too expensive.

For those that are in the process of building up their investments, regular savings can be a great way to counter volatility. By investing monthly in chunks, rather than a larger lump sum in one go, an investor ends up buying more shares or units when prices become cheaper and fewer when they become more expensive; though there are still risks and with all investments, you could get back less than you put in.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Inflation hits 9.1% - what can consumers and investors do?

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