In the financial news, inflation seems to be all the talk of late. The Bank of England has predicted that inflation will hit close to 3% next year and this is a dramatic change from the current deflationary environment. One of the key drivers in bringing inflation to the shores of Britain is the devaluation of the Pound (£). After the brexit vote, the pound has depreciated greatly against most other developed currencies. The devaluation of the Pound makes imports more expensive as you know have to pay more pounds for a given amount of a foreign currency. As imports in the form of products and raw materials rise, businesses are force to pass these costs on to consumers in the form of higher prices and that is the basis behind the inflation we are going to face over the com in years.
How Inflation Will Affect Me Personally
Most people want to know how inflation will affect them personally. Here is a brief list of what inflation can do to your purchases.
- House Prices – When inflation hits, hard assets generally tend to do well. Thus property prices tend to rise with inflation.
- Mortgage payments – Inflation tends to lower the value of remaining mortgage debt in real terms. This is because your mortgage debt is a fixed amount and you are now paying the same amount as before but with a weaker currency. If inflation was to get out of hand, you would see the Bank of England raise interest rates and in this situation, those on variable rates could end up paying more for their mortgage.
- Savings – In an inflationary scenario, people holding on to cash will be losers. This is because cash will lose value in real terms. Say you currently have £100 in the bank and the interest rate is is 3%. Although you will still have the same £100 in the bank next year, your money will now be worth less as you can only buy £97 worth of stuff. The other £3 has invisibly been eaten by inflation. In short, cash savers will have negative real returns.
- Pensions – With many retirees going for the predictability of fixed-income assets like bonds , inflation is an unseen leech that steadily drains the value of retirement savings. The bond payments will be worth less and less in real terms for each year inflation persists. Furthermore, if the bank of england increases interest rates, bond holders face a double whammy as the prices of bonds will drop.
- Dividends from investments – Rising business costs could put less secure dividends
at risk. Investors need to invest in companies that have pricing power. By this I mean, companies that can increase prices, and thus dividends, at a rate above inflation. Consumer staple companies like Colgate Palmolive, Procter and Gamble, Unilever and Reckitt Benckiser act as good inflation hedges as they generally can increase prices without losing customers.
- Travel Costs – As oil is priced in Dollars, the weaker the Pound becomes against the dollar, the higher the price UK consumers will have to pay for oil. Inflation will hit the whole travel sector so expect increases of prices at the pump, on the bus, on trains and on holiday flights
As you can see from the above, inflation is likely to affect you as an individual. This is even more true if your current wage or pay check remains stagnate over the next year. Inflation coupled with no wage increase means that your standard of living will drop as you will now be able to buy less stuff with your money as compared to a year ago.
But as mentioned, inflation is not bad for all. Those with hard assets like houses and gold, or those invested in the right companies, will see their net worth soar with inflation and will do really well over the next few years.