The return of inflation?

Inflation has picked up sharply in recent months, with a potential impact on investments.

Source: Office for National Statistics

UK annual inflation was just 0.4% in February 2021, as measured by the Consumer Prices Index (CPI), or 1.4% measured by the Retail Prices Index (RPI). Four months later it was 2.5%. 

The big question now is whether inflation will abate along with the pandemic. Some economists predict that the inflationary spike will prove ‘transitory’ and the pandemic distortions will disappear over the coming year. However, others fear that the price increases could lead to parallel wage rises, creating a wage/price spiral.

Depleting investments

If you are an investor, rising inflation can often be bad news. With interest rates close to zero, the buying power of any cash you hold is being steadily eroded. If you have more cash than you need for your rainy day reserve, make sure you have a good reason.

The value of the future payments of interest and eventual return of capital for fixed interest payments such as bond funds are similarly eroded by inflation. On the other hand, the appeal – and value – of index-linked bonds typically rises when the spectre of inflation looms and investors seek cover.

In the long term, investment in shares has proven to provide better protection against inflation than either bonds or cash deposits. However, in the short term, inflation can be a drag on some companies’ profits – think of those wage pressures – and depress their share price.

With inflation uncertainty set to remain for some while, it makes sense to review your investments now to make sure you are ready for whichever set of economists proves to be correct. 

The value of your investment and any income from it 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.  

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

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