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Inflation Rises – the risk is real

It seems we’re all being flooded with news stories from the media about rising inflation, higher prices and consumer confidence.

The Bank of England has recently announced that inflation is rising faster than expected; Huw Pill, Chief economist at the Bank of England said the recent rise in prices would prove to be temporary, but the “magnitude and duration of the transient inflation spike is proving greater than expected” which means we could see a sharper rise in general prices than the government and Bank of England had initially planned for.

Firstly, to understand the relevance of the current state of UK Inflation, we must understand what inflation is and what it means to consumers and investors alike.

Put simply, inflation describes the gradual increase in prices and a slow decline in the purchasing power of money over time. In short, a £20 note today doesn’t buy you as much as it used to 20 years ago.

There are two main measures of inflation in the UK, the CPI (Consumer Price Index) and the RPI (Retail Price Index). The CPI is a basket of what is seen as commonly purchased goods and services such as clothes, airline tickets, postage etc. RPI is like CPI but also includes house prices. Typically, we would expect to see RPI higher than CPI.

There are a few factors which can cause inflation, with the main ones being: import prices, taxes, employment, and wages. Currently, the main factor causing inflation stems from the rising costs of imported goods paired with international commodity prices. It has been said that these factors are only temporary and likely to settle once shipping times and the supply of semiconductors normalise. However, in the September policy statement, the Bank of England announced it expected CPI to reach 4% later in the year, as confirmed by Rishi Sunak in the Autumn budget, which is double the 2% target and expects inflation to remain high for quite some time.

This is an alarming piece of news for the ‘person on the street’.

For savers and investors, it is vital to place investment assets in appropriate arrangements, so the capital retains its ‘real’ value, ie; that it doesn’t lose its purchasing power over time due to rising inflation.

The chart below shows the difference between a typical savings rate and inflation over time:

The chart above shows the UK RPI as a measure of inflation over the past 10 years against a typical rate of return you may have expected from a savings account over a 10-year period. If you put £10,000 into a typical savings account it would have grown to £10,963.97, whereas the ‘real’ value of £10,000 from 10 years ago is £12,966.39, meaning the purchasing power of the original sum has reduced by £2,002.42 (the difference between the two figures).

The risk in allowing this to continue over the longer period is that eventually, the real value of capital erodes over time and the capital is not able to buy as much in the future.

Understanding inflationary markets plays a large part in the management of our investment strategies at Francis Clark Financial planning. All recommended solutions are managed to outperform against an RPI benchmark; with the core Cautious strategy benchmarked against RPI +1% to preserve the capital value whilst having some capital growth, and our growth portfolio targeting a 3-year rolling average of RPI + 4% in a 12-month period as shown below.

  FCFP Cautious FCFP Balanced FCFP Growth
Risk Level Low Medium High
Long term expected return RPI + 1% p.a RPI + 2.5% p.a RPI + 4% p.a

For further information on how you can help protect your savings and investments against the eroding effects of inflation, please get in touch.

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