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June 23, 2023

Why patience prevails against inflation

Inflation has stayed stubbornly high over the last year or so.

Whether it’s food prices, heating bills, or mortgage payments, most of us (one way or another) have felt the pinch.

This has been driven mainly by shortages that have persisted since the pandemic, new Brexit regulations and the Ukraine war – which has compounded shortages.

Energy bills (which are driven by wholesale gas prices) have had the most significant impact.

Although the current rate of increase in the cost of living is temporary, it is difficult to predict when it is going to ease. By raising the base (interest) rate by a half of a percentage point to 5.00% this week, the Bank of England has set a new record of 13 consecutive increases.

It remains to be seen whether Rishi Sunak can deliver on his promise to half inflation by the end of the year.

Bad news for our shopping baskets

One of the most notable areas of UK inflation is food prices.

Since last year, for example, the cost of a bottle of milk is up by nearly one third; baked beans up by 41%; and coffee pods are now 20% more expensive. As a whole, the prices of food and non-alcoholic drinks rose at its second fastest rate in more than 45 years in April (19.1%) and remains at a similar level (18.4% as of May this year).

With living standards being squeezed and interest rates on savings increasing (although not at the same rate that banks have been changing their mortgage rates!) it is tempting to react to events as they happen and to listen to the “noise”. That’s why, every now and again, it’s worth stepping back, looking at the bigger picture and reminding ourselves of what we are looking to achieve.

Don’t be tempted to play it short term

With inflation, the Bank of England and interest rates dominating the news at the moment, it’s only natural that we might sometimes have our heads turned by short-term measures. Rising interest rates in bank accounts, coupled with volatile stock markets, mean some investors can look for the so-called “safe haven” option for their money, as they perceive this approach to be less risky.

However, it is worth remembering that interest rates are a tool used by the Bank of England to manage the economy:

•By increasing interest rates, a lever is being pulled to deliberately slow down inflation.

•When this happens, it’s believed that people are motivated to save more, consumers are less inclined to spend, and businesses are more cautious of borrowing.

•Demand for goods and services then fall – resulting in reduced prices.

Therefore, high interest rates are only really intended as a short-term tool, to be applied until they have their desired effect.

Changing a medium-to-long term investment strategy in pursuit of short-term interest rates might actually be riskier than it seems.

When do you take the money out of your investment strategy? When do you re-invest when interest rates start to fall?

So what are we trying to say?

Financial planning can sometimes be a bit like playing Jenga, the classic family game which involves carefully removing pieces from a tower of blocks, before placing them on top as it grows taller and taller. Take the wrong block out at the wrong time, and whole thing comes crashing down.

To continue this analogy, your financial plan has many layers – goal setting, planning for the unexpected, investing appropriately and managing risk over the intended term. Removing the wrong piece from this “block” might result in unexpected consequences.

We can’t predict when inflation and interest rates will start to come down significantly, but that the pattern of increasing interest rates is temporary. A lever that has been pulled.

Investment patience is rewarded

Patience is essential in order to trust in your investment strategy and financial plan, and to avoid making decisions in reaction to short-term noise.

June 23, 2023