Before we answer these questions let us look at, what inflation actual is?
Inflation is a measure of the cost of living: the rate at which the price of goods (such as food) and services (such as train tickets) increase over time.
High inflation: means you cannot buy as much with the money that you have. If wages do not rise in line with inflation, then living standards fall.
Interest rates (rates for credit/loans) are used by central governments to stop inflation rising to high. The Bank of England sets a target of 2% to keep inflation low and stable.
Low inflation: this is where prices are rising slowly (still rising). This tends to be good for consumers because prices are not rising faster than wages.
However, if inflation is too low people might be put off spending which can be bad for companies and cause people to lose their jobs and inevitability lead to an economic downturn.
How is inflation currently measured?
Inflation is measured using a shopping basket. Well, not literally.
Every month, the Office for National Statistics (ONS) looks at around 180,000 prices of around 700 items that it puts into its ‘shopping basket’ of goods.
The average price is compared with last year’s figures to work out the Consumer Prices Index (CPI) measure of inflation that we use as a target.
The current inflation rate is 2.5% in June 2021, meaning prices (on average) are 2.5% higher than they were a year ago.
A ‘shopping basket’ of goods is used to measure the inflation figure each month
Why is inflation going up?
The CPI measure of inflation tripled between March and May 2021, rising from 0.7% to 2.1%, with price rises happening in:
- transport – petrol and diesel, up 17.9% over the past year
- clothing – up 2.3% in May
The rise in inflation has investors troubled. Higher inflation could mean higher interest rates, explains Sarah Coles of Hargreaves Lansdown, which “could make life harder for every business and household that has been borrowing its way through the crisis”.
“At current levels, inflation is nothing to fret about, but there is rising concern that the fiscal and monetary response to the pandemic has sown the seeds of an inflationary scare further down the road.
Laith Khalaf, financial analyst at AJ Bell
How does rising inflation affect savers?
Rising inflation is bad news for savers. The rates paid on standard savings accounts are unlikely to beat the price of inflation, meaning the value of your pot is being eroded in real terms.
- If inflation is rising by 2%
- And the best paying easy-access savings account pays 0.5%
- This means that the value of your savings is being eroded faster than the money you are earning in interest
What does inflation mean for investors?
Most people think £1 is and will always be worth £1, unfortunately this is not actually true, yes that £1, will still be £1 but if after a year of inflation, what can you buy with that £1 will have decreased.
This reduction is known as a reduction on your “purchasing power” of that £1.
Its always important to think about your budget in retirement and too always factor inflation when you do this.
An income target of £25,000 today might be actually closer to £30,000 in todays terms when you get there..
In all our cashflow reports, for our clients we include a standard 2% inflation ratio to ensure that our clients income target today is met and factored in to ensure their lifestyle goals are met in their future life.
If you would like a report of your portfolio inflation adjusted, please do get in touch with one of our financial planners below
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