The consumer price index (CPI) is at highest in more than a decade. And there are many signals pointing towards the Bank of England putting up interest rates for the first time in three years.
Inflation and interest rates have been rock bottom for several years, so what happens now? When these big changes occur, it’s time for calm heads when thinking about the impact on your financial plans.
The CPI – the basket of goods used to calculate rising prices – is at its highest level since 2011. This is mainly a response to soaring energy costs, especially gas, which have put several suppliers out of business, and are likely to see large hikes in power bills for many UK homes.
There are other factors too, such as higher prices at the petrol pump and supply chain problems, which are bumping up costs for food, building materials and many more items essential that keep the economy ticking over.
To counter this, the Bank of England, which has an inflation target of 2%, is very likely to rise interest rates. Rates have been ultra-low since the beginning of the pandemic (at 0.1%). In fact, they haven’t gone up since 2018.
Inflation and interest rates explained
Inflation is the rate that goods and services go up in price over time. It’s a good shorthand for how an economy is faring.
A little inflation is a good thing: it drives the economy forward as people head out and spend. Without it, people would hold off buying non-essentials, waiting for a fall in price.
Too much inflation though, and an economy can be heading for trouble, as the pound in your pocket becomes worth less and less. Central banks, like the Bank of England, try to keep inflation in check using interest rates (the cost of borrowing). This encourages people to save rather than spend and slows the increases in prices.
It’s a balancing act though. Raise them too much and you risk damaging the economy.
It’s strange to think that there’s a whole generation for whom this is a totally new experience. The Bank of England base rate hasn’t been above 5% since 2008 and mortgage rates have stayed consistently low. And even though living costs have risen in the last 30 years, the monthly inflation rate hasn’t risen above 3% since 2012. We’ve all become accustomed to another new normal.
There are two very important things to remember here:
A timely reminder
So, the message is, there’s no need to panic.
However, the headlines about inflation are a timely reminder about the reason we invest in the first place – because it gives you a better return on your cash. Over time, inflation can erode the value of your money – if you had £1,000 to spend in 1990, it would be equivalent to around £400 now.
While in the short term, it’s advisable to have money for known expenditure or in an emergency, held in your bank or savings account with little or no withdrawal charges. For the longer term, if you want to protect your capital from being eaten away in value by the impact of inflation, you need something that offers a better return. The chart below gives one example of the above-inflation returns that are possible by investing, comparing an investment fund, the UK retail price index, and a representation of a standard savings account.
That’s the reason that financial planning is so important. We recommend taking a diversified approach investing your capital so that you can guard it against various kinds of risk and help give yourself greater reassurance for the future.
Speak to us if you want to find out more about how inflation and investing.
The value of investments may go down as well as up and you may get back less than you invest.
Past performance is not a reliable indicator of future performance.
