How inflation affects your savings and investments

08 February 2017

Inflation has reached a 30-month high, with higher air fares, food costs and petrol prices fuelled by the weak pound all helping to drive up the cost of living. We examine what rising inflation means for savers and investors and look at which companies tend to fare well in inflationary environments.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • Which factors create inflationary pressure.
  • What impact inflation has on your savings and investments.
  • Which investments can help you combat inflation.

The UK’s Consumer Prices Index (CPI) measure of inflation, which tracks how the prices of hundreds of household items change over time, jumped to 1.6% in December, up from 1.2% in November.

Analysts had anticipated a rise to 1.4%, but inflation rose more sharply than expected due to steeper air fares and food prices, according to the Office for National Statistics.1

The Bank of England said last November that inflation would rise to 2.7% in 2017 and 2018, and that it’s likely to take until 2020 for it to return to the UK Government target of 2%.2

What causes inflation?

There are several different factors that may create inflationary pressure in an economy. Rising commodity prices can have a major impact, particularly higher oil prices, as this translates into steeper petrol costs for consumers.

Stronger economic growth pushes up inflation too, as increasing demand for goods and services places pressure on supplies, which may in turn lead to companies raising their prices.

The falling pound since Britain’s vote to leave the EU in June last year is also contributing to higher inflation in the UK, as it makes the cost of importing goods from overseas more expensive.

Although economic growth in the UK has held up since the referendum, Bank of England governor Mark Carney has warned that households would see “very modest” growth in their incomes in years to come. The Bank of England predicted last November that Britain’s economy would grow by 1.4% this year, double the 0.8% it predicted three months earlier.3

The impact on your savings and investments

Inflation is bad news for savers, as it erodes the purchasing power of your money. Low interest rates also don’t help, as this makes it even harder to find returns that can keep pace with rising living costs.

Higher inflation can also drive down the price of bonds. These become less attractive because you’re locked in at interest rates that may not keep up with the cost of living in years to come.

One option is index-linked gilts, which are government bonds whose interest payments and value at redemption are adjusted for inflation. However, if they’re sold before their maturity date, their market value can fall as well as rise and so may be more or less than the redemption value paid at the end of their terms.

Investing in equities can potentially provide better protection against inflation than deposit accounts or bonds, which aren’t index-linked, because companies can raise prices to cover higher costs. That, in theory, should enable them to grow at the same rate of inflation over time.

However, investing in equities carries a high risk of losses and you must be prepared to accept that you could get back less than you put in and that the value of your investment may not keep up with inflation.

Companies that can help combat inflation

Companies that raise their prices in line with inflation tend to fare better than others when the cost of living is increasing. Energy companies, for example, may perform well in an inflationary environment as they can raise their prices in line with inflation. Infrastructure companies such as those responsible for toll roads, government buildings and hospitals, may also do well, as they often have long-term government contracts in place with payments linked to inflation, which encourages private-sector investment.

Other companies that tend to be resilient to inflation are those producing consumer staples, which will always be required, regardless of what happens to prices. These include companies that produce food and drinks or other essential items such as cleaning products, toothpaste and prescription drugs.

Please bear in mind that our mentioning these kinds of companies doesn’t constitute a recommendation and if you’re unsure about investing you should seek professional financial advice.

Remember that investments can fall as well as rise and you may get back less than you invested. Past performance isn’t a reliable indicator of future performance.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

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