Is inflation bad for your wealth?

Neil Birrell

Premier Miton's Chief Investment Officer

This update should not be taken as advice. If you are unsure about any of the content please contact your financial adviser. Please remember that the value of stock market investments will fluctuate and investors may not get back the original amount invested. To assist, where appropriate, a glossary explaining some of the terms used has been provided at the end of this update.

I usually write these notes around the end of each month and try to discuss topics that you might find interesting, or at least, that I find interesting. Inevitably, for the last year, rising inflation has been a constant theme. Therefore, I thought it might be worth writing a note specifically on the subject, as it is front and centre of our lives at present. It will impact your investments and your life.

Where did it come from?

If I were to look back further in time at these notes, I have little doubt that inflation was mentioned a few times as a likely outcome of the economic support packages provided by governments and central banks though the pandemic. At the time, let’s not forget, it would have been seen as a “price worth paying” to ward off a debilitating recession.

As we rebounded from the COVID induced downturn, inflationary pressures increased and were turbo charged by the jump in oil and gas prices a year ago as supplies were interrupted; you will remember the queues at petrol stations. It wasn’t just petrol, there were supply chain shortages in many industries as companies couldn’t meet the rapid jump in demand post COVID; McDonald’s even ran out of milk shakes. The impact is simple; lack of supply means prices rise which is inflationary.

The problem was exacerbated by the invasion of Ukraine by Russia, which had an immediate impact on the supply and price of energy, food and many other goods.

Inflation had arrived; quickly and aggressively.

There are other reasons for inflation to head upwards; strong economic growth or big wage increases that stimulate demand for goods and services have the same effect.

Is inflation itself a bad thing?

In itself; no.

In fact, a modest level of inflation is a good thing. It helps economic growth, it allows companies to increase the price of their products, which allows for wage increases.
Rising house prices generate wealth and spending in the economy. In fact, central banks and governments (policy makers) around the world target a low level of inflation; the US central bank targets an annual increase of 2% in the Consumer Price Index (CPI), the most commonly used measure of inflation.

Maybe a better way to look at it is to consider deflation; falling prices or CPI. This has the opposite effect; reducing demand and slowing economic growth, possibly leading to recession or worse, depression. Some inflation is good.

Is too much inflation a bad thing?

Yes.

Simply, prices can rise steeply and quickly, meaning your ability to purchase the same level of goods and services is negatively impacted and your standard of living will fall. Furthermore, as a result, it is likely that reduced demand will lead to the providers of goods and services experiencing less demand, which can lead to falling profitability and rising unemployment.

What can be done about it?

The simple answer is; there are not many options.

Sharply rising inflation will decrease by itself over time, as its negative impacts are self-mitigating. However, policy makers, correctly, fear the medium to long term damage it does and change policy to dampen inflation and get it back down to levels that are a positive for the economy and our standard of living.

The most important tool is to put interest rates up. The impact of that is twofold. Firstly, it encourages saving of cash, as the return you will receive rises and secondly, it discourages borrowing, as the cost of borrowing rises. Taking on debt and investing it stimulates growth. Companies do this to make more profits and individuals may do so to buy properties or investments.

The problem is that interest rates are a blunt tool. There is no way of knowing how much inflation will fall by if there is an increase in interest rates of, for example, 0.5% furthermore, there is a lag effect; the day that the increase takes place does not mean that spending or investment decisions change that day. It would be normal to consider the impact and also ponder what might be coming next.

What is the impact of rising inflation and therefore rising interest rates?

It means that the returns from cash savings improve and the cost of borrowing rises.

That second point is the most important one. As you will know, if you have a variable rate mortgage, the cost of your mortgage will rise, as will the interest rate on new fixed rate mortgages, and that is likely to have a negative impact on house prices. If you rent, it is likely to feed through there as well, as the costs for the landlord have risen. But it has huge ramifications throughout the economy.

Companies often borrow money to invest in machinery or research or new product promotion, amongst many other things. If the cost rises, that is less likely to happen; growth prospects worsen and employment prospects would as well.

In other words, the outlook for the economy and our standard of living softens. Rising interest rates imply slowing economic activity and wealth generation.

What does that mean for my investments?

That depends on the type of investment.

If it is bonds, those issued by governments or companies, it is likely to be negative. Rising inflation means that the future monetary value of the bond is reduced. Furthermore, bonds typically pay a fixed rate of interest; as the interest on cash deposits rises, the attraction of investing in bonds falls.

For company shares (equities) the risk is that profits will fall as demand for their products falls. Therefore, stock markets are at risk. Real estate, as noted above, could come under pressure. You might expect commodity prices such as oil, gas, metals and agricultural products to be negatively impacted as well, as demand falls. However, while gold is often seen as a safe haven in periods of rising inflation,it hasn’t been this time!

Inflation is at highs not seen for decades, interest rates are going up and the outlook is bleak. Should I be selling my investments?

That is not a decision I can or would make for you.

But I can tell you that financial markets take into account what has happened, but more importantly, what it is thought will happen. In other words they discount expectations for the future, including what might happen to inflation and interest rates. Therefore, unless things turn out worse than expected, the prices of different types of assets reflect the outlook.

I don’t know the answer, but asset prices have fallen so far that, it seems to me, that there is a lot of bad news already taken into account, particularly in bond markets.

Central banks will keep putting interest rates up until inflation is beaten. They have decided that the risk of recession is the lesser of two evils; inflation being the greater. For what it’s worth, I agree with them.

And never forget; it’s an economic and financial cycle, it always has been. It goes up, it goes down and it goes up again. Investments should be for the long term, throughout the cycle, not for a part of the cycle.

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Risks

All types of investment carry a degree of risk.  It is possible you could lose some, or all, of the money you invest. The level of risk varies depending on the type of investment.

Reference to any particular investment or asset class does not constitute a recommendation to buy or sell the investment or asset class.

Equities (shares) can experience high levels of price fluctuation.

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

Where investments in a fund are denominated in currencies other than sterling (for example, if a fund holds assets priced in euros), its value will be affected by changes in the relevant exchange rate. Certain other investments, such as the shares in companies with profits from other countries, will also be effected.

Past performance of a fund is not an indication of how it will perform in the future. The share price of funds, therefore the value of your investment in the funds, and any income from them, can go down as well as up, and you could get back less than you invested.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Property values can rise and fall sharply depending on the strength of a country’s economy.

Changes in central bank interest rates can affect all types of assets, in particular, securities such as government bonds and corporate bonds that generally offer a fixed level of interest. If interest rates go up, the value of a bond may fall, and vice versa.

Future forecasts are not reliable indictors of future returns.

Glossary

Asset class

Different groups of investments such as company shares, bonds, commodities or property.

Bonds (or fixed income)

Types of investments that allow investors to loan money to governments and companies, usually in return for a regular fixed level of interest until the bond’s maturity date, plus the return of the original value of the bond at the maturity date. The price of bonds will vary and the investment terms of bonds will also vary.

Deposit

An amount of money placed with a bank or other financial institution; these may take different forms and have different names, such as certificate of deposit. Deposits may pay fixed or variable rates of interest and may have set maturity dates.

Equities

Another name for shares (or stock) in a company.

Maturity

The set date on which a bond or similar loan will be repaid by the borrower.

IMPORTANT INFORMATION:

The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the content of this document, please speak to a financial adviser. The value of stock market investments will fluctuate, which will cause fund prices to fall as well as rise and you may not get back the original amount you invested.

Whilst every effort has been made to ensure the accuracy of the information in this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, we may monitor and record calls for training and quality-assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227.  Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

007899/211022

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Disclaimer

This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

You acknowledge that such information may contain inaccuracies or errors and we expressly exclude liability for any such inaccuracies or errors to the fullest extent permitted by law. Your use of any information or materials is entirely at your own risk, for which we shall not be liable.

The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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This section of the website and the content it contains is for professional financial advisers only and should not be relied upon, or circulated to, retail clients. Retail clients should refer to the Private Investor's site.

The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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