Lowes Magazine Issue 119

DOUG’S DIGEST

INFLATION, OR HOW MUCH THE PRICE OF A BASKET of goods and services rises each year, is one of the main reasons people need to invest. We have discussed inflation here before, and how the figure declared by the Office of National Statistics is likely to be very different to the figure experienced by each of us in real life, but it has been the rate at which inflation is increasing that has made it the hot topic in many recent economic reports. At the time of writing the Consumer Prices Index (CPI), the government’s chosen measure for inflation, sits at 2.5%, up from 2.1% the previous month and just 1.5% in April. Before last month it was almost two years since it has been above the 2% target set by the government, and it is a sharp increase since August last year when inflation was only 0.2%. More importantly, it is expected to increase further from here. A little inflation is a good thing for investors. Rising prices tends to mean there is more demand than supply, so if businesses can increase production to meet that extra demand then at the same time they are going to increase their profits, which in turn benefits investors in that company. Inflation can also be beneficial for borrowers – including governments who have had to borrow heavily over the last year to pay for furlough schemes and increased benefits at a time when their tax income was falling. If the repayments are fixed, while inflation is causing our incomes to rise, then the percentage amount of income used to maintain that debt reduces over time. Those who have had a mortgage to buy their home will have seen this, where the monthly repayments were a large proportion of their income to start with, but were more easily managed after 25 years. The worry at present is how quickly inflation is rising, and more importantly how quickly it will continue to rise in the coming months. Whilst a little inflation is a good thing for the economy, too much can be damaging. If prices rise too quickly then people have to spend more on essentials and have less to spend elsewhere, leading to falls in demand. Also, people demand higher wages to cover their increasing costs, which in turn causes costs to rise, leading to a spiralling problem if allowed to go too far. So is inflation becoming a problem? Well, the buzz-word at the moment is “transitory”. Is the rise in inflation transitory and will it fall back some time soon, or can we expect higher levels of inflation to be with us for an extended period? Inflation rising

The important thing to remember is that the rate of inflation measures the increase in prices since the same time last year, and last year we were in

unprecedented times. Whilst we all had to continue buying essentials such as food a lot of other purchases, such as fuel for transport,

fell dramatically as we all stayed at home. It is this lower base for the cost of the basket of goods last year which will cause the higher inflation figures we will be seeing in the coming months. It is interesting to note that whilst inflation in June stood at 2.5% for one year, it was only 3.15% for two years, giving an annualised rate of 1.56%. That is still below the government’s target of 2%. As we move forward through the next twelve to eighteen months, prices will once again be compared to more normal levels and a truer picture of inflation will emerge, with rates expected to reach their highest levels later this year before falling away. It will only become a problem if we see price inflation leading to a sustained increase in wage inflation also. We are starting to see signs of that, but whether this is a short term or long-term trend remains to be seen. The events of the past year have seen people re-assessing careers and working lives, with some deciding to take early retirement for example. This has led to a tightening of the work-force, putting people in more demand and able to ask for higher wages as a consequence. As government support schemes come to an end, businesses will have to assess whether they can afford to bring all their staff back onto the payroll and this is sadly expected to lead to some job losses. How much of an effect this will have is unclear, but in the UK we have a second potential factor as a result of Brexit and the pandemic. Last year’s lock-downs saw migrant workers leaving rather than staying in the UK with no work. It is not yet clear if they will return as restrictions are lifted, or decide that the changes introduced following Brexit now make the UK a less attractive destination. Migrant workers form a large part of the workforce in the UK, especially in certain industries such as agriculture, which could have a big effect on costs. So, as we all breathe a sigh of relief as restrictions on how we live and work come to an end, inflation is just one topic that shows the full effects of the past year will not be known for some time, and something we will certainly be keeping an eye on.

UK CPI Inflation vs Target Level

113

112

UK CPI Basket Value Increasing at 2% Target

111

110

109

108

Source: Office for National Statistics.

107

Jul 19

Jul 20

Jun 19 Jun 21 Despite recent sharp rises, the price of the basket of goods used for CPI is still below where it would have been if it had increased by the UK target of 2% p.a. Aug 19 Sept 19 Oct 19 Nov 19 Dec 19 Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20 Aug 20 Sep 20 Oct 20 Nov 20 Dec 20 Jan 21 Feb 21 Mar 21 Apr 21 May 21

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