Most people who have been to the barber’s, a restaurant or on a UK break recently will recognise the feeling of slight surprise when paying the bill.
After months of staying at home and spending little, not only are we back out into a world where we can buy most of the services we were used to receiving before, but they have gone up in price as well.
Inflation - the gradual rise in the price of everything we spend - is on the up.
Why inflation is happening now
The most recent figures show that inflation, as measured by the Consumer Price Index (CPI) is rising by 1.5 per cent at the moment. The Bank of England, which is responsible for controlling inflation, has a target of two per cent price growth, but the Bank’s own projections suggest that it is likely to rise above this towards the end of the year.1
There are several reasons why the rate of inflation is high and rising. The main reason is the rising cost of energy, including utility bills as well as petrol, however, the prices of clothes and footwear are rising too.2
Some of this is a post-lockdown effect - we are comparing with lockdown prices where there was a lack of demand for many things and prices fell, but there is also the cost of Covid-19 and Brexit to contend with going forward, meaning that the cost of services could rise due to social distancing demands and hygiene measures as well as Brexit-related increases in food costs.3
Inflation is a global issue, with the OECD saying that currently rates in its member countries is higher than at any other time since 2008.4
What economists think might happen next
While the Bank of England is forecasting inflation rises in the short term, economists do not all agree about how long the rise will last or what should be done about it.
Some, such as the Band of England’s Andy Haldane, believe it will be a more permanent phenomenon, and urge caution.5 Former US Treasury Secretary Larry Summers, Treasury secretary in the Clinton administration, also thinks inflation is a long-term risk and has warned about “dangerous complacency.”6
Others, such as KPMG’s chief economist Yael Selfin, believe that we should not be concerned about inflation, and that it will work itself out in the short term.7
Why it matters for wealth
Inflation matters for our wealth because it erodes real-time purchasing power. Money in savings accounts at rates lower the one of inflation will lose its value over time.
It is better news for investments, as long as it doesn’t run too wild. The stock markets like a ‘goldilocks’ version of inflation - not too hot, not too cold. Sectors that do well in an inflationary environment are the more commodity-focused ones – metals and mining, autos, chemicals, energy, semiconductors, and banks.
Stable growth companies such as consumer staples, insurance, healthcare and utilities, tend to underperform. Investments paying a fixed return, such as government and corporate debt or property companies, also become less attractive.
Ultimately, investments are more likely to outrun inflation than savings in cash, but it is important to ensure that your money is correctly positioned if prices are rising. In any case, the waters are looking choppy for a time, whichever economists you choose to believe.