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The UK is now facing its highest inflation rate since the Falklands War in 1982 – possibly set to reach a 40-year high of 8.7% later in the year. This is far higher than the 2% target set by the Bank of England (BoE), and has many people wondering what this means for their wealth and finances. In response to rising inflation, the BoE has voted (8-1) to raise interest rates for the third time in 6 months – to 0.75%. Whilst this marks a return to the base rate in 2018-19, it does raise questions about the near future. Will interest rates go even higher to control inflation? If so, how might this impact households across the UK?
Already, the new 0.75% is impacting the economy (e.g. high street bank rates and mortgage deals). Below, we unpack this in more detail and how it may affect your financial plan in the months ahead. We hope you find this content useful.
If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
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Inflation drivers in 2022
A number of factors are contributing to the rise in UK inflation (which, in turn, puts pressure on the BoE to raise the base rate). The war in Ukraine, of course, is the most prominent one in the headlines right now. The invasion is causing huge disruption to global supply chains, especially since both Ukraine and Russia are major producers of important goods – the former agricultural products; the latter oil and gas. Countries that are “net energy importers” like the UK, therefore, are particularly affected by these geopolitical events (that are largely outside its control).
Energy prices were already rising before the invasion in February 2022, however. There was a particularly cold winter in Europe last year, driving up demand and leading to a depletion in gas reserves (causing, in turn, more reliance on Russia’s supplies). The end of the 2022 January sales also contributed to a rise in prices for clothing, footwear, furniture and flooring – marking a reversal to the trend at the same time last year (when shops were forced to shut due to Covid restrictions). Inflation, in short, does not appear to be going away any time soon in 2022.
Possible further rate rises
The BoE has not ruled out further possible rises to the base rate, following its decision to raise the rate to 0.75% in March. For savers, this may appear to be good news. After all, their banks have, historically, also raised their rates on regular accounts when the BoE has put up the base rate. However, so far high street banks have been reluctant to pass this benefit down to their customers. Natwest Chairman Howard Davies has put this down to a “competitive market”, and only 10% of banks and building societies have passed on the last rate rise, completely.
However, banks have been more than happy to raise mortgage borrowing costs in response to the base rate rise. Most of the competitive sub-1% mortgage deals came in 2021, moreover, have been pulled from the market. In February 2022 alone, over 500 deals were removed by lenders. More could follow in the months ahead if the BoE decides to raise rates further.
When interest rates go up, it also increases the cost of borrowing for the UK government. This means that new bonds on the market typically become more attractive to investors, since they can achieve a higher interest rate on the “loans” they offer. This can lead to greater volatility in the stock market, as more “cautious” investors pull their money from “riskier” stocks and put it into “safer” bond investments. However, higher inflation also pressurises investors to put money into assets like equities (stocks) to achieve the “real returns” they are looking for.
A few notable points need to be made in the face of this complex investment landscape. First of all, be careful not to hold too much in cash. Whilst this may seem like the “safe” option during a time of uncertainty, the low returns offered by savings accounts will result in much of the value getting lost (due to high inflation). A good rule-of-thumb is to save 3-6 months’ of living costs set aside in an easy-access account, ready for emergencies. Anything extra can almost certainly be put to greater use elsewhere.
Secondly, consider reviewing your investment strategy with your financial adviser to make sure it still reflects your goals. Given the present inflationary environment, it may be that certain funds need replacing with others to help achieve the “real returns” you are looking for. Alternatively, it may be that some investors need to “de-risk” aspects of their portfolio.
Helping your child onto the housing ladder is a noble aim. However, make sure you do not inadvertently harm your wealth and finances – or that of your child – without a strong tax plan.
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