News
Rising Inflation
04/07/2008
Following the leap in the Consumer Prices Index (CPI) from 2.2% to 3% in April the CPI has risen to 3.3% in May. According to figures recently released, by the Office for National Statistics (ONS), this is the highest recorded figure since 1997. The biggest contributor to consumer inflation was the rising price of food and non-alcoholic drinks, the ONS said. There were further pressures from housing and household services due to gas and electricity bills, together with heating oil prices. The Retail Price Index (RPI) which includes mortgage repayments also rose to 4.3% in May, up from 4.2% in April.
As inflation has risen more than one percentage point above the government’s 2% target, the Bank of England governor, Mervyn King, has written a letter to the government to explain what action the bank is taking to control consumer prices. In his letter to the chancellor he blamed sharp rises in the prices of food and energy for the increase in the rate of inflation. "As things stand, inflation is likely to rise sharply in the second half of the year, to above 4%," Mr King told the chancellor.
While CPI measures the average change from month to month in the prices of consumer goods and services, it does not necessarily measure the actual inflation rate experienced by individuals. Those people whose incomes are fixed in money terms suffer most from inflation. This is because as inflation rises the real value of capital will be eroded.
Inflation is very damaging to cash current accounts, a large number of savings accounts and the vast majority of term deposits and building society bonds that have a fixed rate. While interest rates are likely to go up as inflation rises it does not compensate for the diminished spending power of the cash held in this type of investment. In fact, governments’ inflation is doubly damaging because the market value of bonds falls as inflation rises, as well as the interest paid being fixed.
Equities are perceived to be a good hedge against inflation because efficient companies will endeavour to increase their profits in line with inflation. Rising company profits will mean increased dividends and /or growth in the capital value of shares. Historically only equities have statistically grown in real terms making investors wealthier over the long term.
Equity income funds have long been a favourite of British investors. They aim to deliver a dividend stream up to 10 per cent higher than the FTSE average while also striving for capital growth. Some of the biggest names in fund management work in this sector, and over the past five years the best-performing funds have almost doubled investors’ money, according to Morningstar, the fund analyst.
However, equities should always be seen as a long term investment as over the shorter term equities can lose value and there is no guarantee that income will be paid.
While we consider inflation to be a concern in the United Kingdom the CPI shows that the UK inflation rate in April, at 3.0 per cent, was below the provisional figure for the European Union as a whole of 3.6 per cent.
Speaking recently Mr King said that the Bank had the “right framework” to make sure inflation returned to the government’s 2% target and that economic growth recovered. He also said that the Bank’s rate setting Monetary Policy Committee was “prepared to take whatever action is needed” to bring inflation down.
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