In recent months, you may have seen that inflation in the UK has been rising due to a combination of several economic factors.
According to figures from the Office for National Statistics (ONS), the rate of inflation in the UK rose by 2.9% in the 12 months to September 2021. As you may know, while some inflation can be beneficial for the economy, too much can have adverse effects.
If you are wondering what this could mean for your finances, read on to find out three of the main ways that it could impact you.
1. It will reduce the buying power of cash holdings
One of the most obvious ways in which inflation can impact your wealth is that it erodes the buying power of your money. This is obviously a problem if you hold a large portion of your wealth in cash.
Keeping some of your money in this way can be useful for building financial stability, such as keeping an emergency fund. However, having too much cash can leave you exposed to the impact of inflation in an environment where cash interest rates are at record lows.
While a 2.9% annual rise may seem deceptively small, in the long term this incremental increase in the cost of living can have a serious effect. The easiest way to see this is with the Bank of England’s inflation calculator, which can show you how inflation affects prices in the long term.
For example, if you wanted to buy £10,000 worth of goods and services in 1990, it would have cost you £10,000. However, if you wanted to buy the same in 2020, it would cost you £23,244 due to an average rate of inflation of 2.9% throughout the period.
Furthermore, even if inflation was to remain steady at the Bank of England’s target of 2% a year, your cash would be worth one-third less in real terms after only 20 years.
2. Higher inflation may prompt a rise in the base rate
For the past few months, many Brits have benefited from low interest rates, which have allowed them to borrow money at a significantly reduced cost. However, this may soon change if inflation remains high.
As you probably know, the Bank of England has significant financial powers at its disposal to influence the economy. One of the most important tools it has is the ability to raise the base rate.
To put it simply, this is the interest rate that the Bank of England charges other financial institutions to borrow money. As such, the base rate influences the interest rates that they then offer to their customers.
Source: Bank of England
For more than a year, the base rate has sat at a record low of only 0.1%, but this could change if inflation was to increase.
While a change in interest rates may be good news for savers, it could seriously impact anyone with a large amount of debt. One group who could be affected the most are mortgage holders, as they may see the cost of their monthly repayments rise significantly.
If you have any variable-rate borrowing, a rise in interest rates is likely to see your repayments rise. On a £400,000 repayment mortgage with a term of 25 years, even just a 0.25% interest rate rise – from 3% to 3.25% – would result in your monthly repayments rising by around £53 (using the Which? mortgage calculator).
Speaking in an online panel on 16 October, governor Andrew Bailey was quoted by the Telegraph as saying that the Bank of England “will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.”
However, despite the Bank’s own predictions that inflation could reach 4% this winter, according to the Guardian, the Monetary Policy Committee voted unanimously in September to keep the base rate at its current level.
3. You may need to reassess your risk tolerance when investing
Another potential issue is that your investments will need to work harder to generate returns in order to outpace the rate of inflation. This may mean that you need to reassess your investing strategy.
While your investments may appear to show reasonably strong growth, if there is a high rate of inflation then their real value may not be increasing by as much as you think. Furthermore, if you have low-risk and low-return investments then you may even be losing money in real terms.
If you want to grow your wealth, it is important to ensure that your investments work hard for you. That’s why, if you’re concerned about the performance of your portfolio, you may gain more peace of mind by getting in touch with your financial planner.
If you aren’t already receiving professional advice, doing so could help to protect your wealth from the impact of rising inflation. Our portfolios are designed to align with the compliance requirements of major professional services firms, so we’re ideally placed to build an investment strategy that works for you.
Get in touch
If you want to talk to someone about whether you should reassess your investing strategy, get in touch. Please email firstname.lastname@example.org or call 0345 450 5670.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.