Understanding Inflation
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Inflation in the UK is currently around 10.4%, which is 8.4% higher than the Bank of England’s target of 2% (it’s their job to get it back down here). Let’s take a look at what inflation is, why it happens, and what you can do to combat it.
What is inflation?
Inflation is the increase in the price of goods and services. The rate of inflation is how quickly it happens. The rate of inflation can be measured in months and quarters, but is normally measured year-to-year.
How does inflation affect money?
There are two ways to think of this: the price of goods, and the ‘value’ of money.
The price of goods — 10% inflation means a pint of milk that used to cost £1, will cost £1.10.
The value of money — You start with £100. Inflation reaches 10%. You still have £100 cash, but it is ‘worth’ £90. Or put another way, you’d have to spend £110 to buy £100. Your money doesn’t go as far.
Commodities and basic foodstuffs tend to be the most obviously affected by inflation. Energy, flour, bread, milk, eggs, fruit and vegetables, and so on. But really anything can be affected by inflation, even services like builders and plumbers who need to account for raw materials.
Rate of inflation today
As mentioned, it’s the Bank of England’s job to keep inflation at around 2%. According to Rate Inflation, this has generally been the case in recent years. Across 2022-2023, it’s been a significant outlier because of the same factors you’ve heard so many times already.
The war on Ukraine pushing up energy prices, multiple lockdowns in China (where many goods are made), post-pandemic work and lifestyle changes. It’s a frustrating storm that’s sent inflation soaring.
Graph Source: Office for National Statistics
Will inflation come down?
The Bank of England forecasts inflation to fall this year. There are signs that inflation might now have turned a corner. It stopped rising around the middle of last year and has been roughly stable since then. The Bank of England expects inflation to begin to fall quite sharply from the middle of this year.*
Investing during inflation
For tips on investing to beat inflation, we turn to our old pal, Warren Buffett.
- Invest in companies with low capital needs. That means businesses which don’t need to pump in a lot of raw materials in order to turn a profit or grow. Think software brands, for example.
- Invest in companies with pricing power. That is, companies which can raise prices during inflation, beating the competition and offsetting costs.
- Invest in yourself. Aim to be the best at whatever it is that you do, and you’ll increase your value, your own purchasing power, and be able to command a fair salary.
- Limit your wants. Buffett says that you can’t worry about spending too much, or not having enough money, if you don’t want for too much to begin with.
Want to learn more about investing in times of market volatility? Read more here.
