Higher inflation: What it means and how to survive it
Inflation in the US, UK and elsewhere has not been this high for decades. What does that mean for investors?
American consumers are paying 8.5% more today for everyday goods than a year ago. That’s the highest rate of price increases in more than 40 years.
In the UK, the year-on-year increase in prices is at 6.2% – again the highest rate in decades.
Inflation is being experienced all around the world as prices of food, fuel, electricity, and many other items that make up our routine shopping are going up fast. This marks a distinct change. In recent memory, inflation in most developed economies has been low.
So what’s changed, and what does it mean for investors?
What is inflation?
Inflation describes a change in prices. Where official consumer inflation statistics are provided on a national basis (such as the figures for the US or UK above) they are usually calculated by governments. They work out price changes by tracking a basket of commonly-bought items. These will include food and drink, clothing, footwear, transport and energy costs, for example.
There are other types of inflation measures. Producer price inflation, for instance, tracks the prices manufacturers pay for the raw materials needed to make their goods. There are also measures for house price inflation or energy inflation.
If the inflation rate is being reported as at 5% year-on-year, it means that prices in general are 5% higher than they were this time last year.
From 5p to 50p in five decades: real-life price rise of a pint of milk
In January 1971 the average price for a pint of milk in the UK was just five pence. It remained roughly that level until 1975, after which it crept up gradually to just under 40p in the 1990s. The steepest increases have come recently. In April 2021 a pint of milk cost 42p. In March 2022, that reached 50p: a 19% increase in under a year.
What causes inflation?
Inflation has several potential causes. Economists talk of two main types: “cost push” or “demand pull”. If the costs of producing goods and services rise, consumers face increased prices for end-products: this is “cost push”.
But prices can also rise where there is more demand for something than there is capacity to supply it: this is “demand pull”.
Today’s inflation is being driven mostly by cost pushes. Energy is a component in most goods and services, and when as now its price rises, producers will need to pass on the cost. Supply disruption in China and elsewhere, caused by the Covid pandemic, had a similar effect. The supply of components, consumer electronics and auto parts fell, causing their prices to rise.
Why is too much inflation seen as a problem?
The most obvious danger of inflation is that if prices rise faster than incomes, people can afford to buy fewer goods and services. This can mean a fall in standard of living.
In practice, inflation’s negative effects are more subtle, impacting different groups in different ways, and having a broader destabilising effect on societies.
These are just some of the negative effects of inflation:
Inflation is hardest for those on fixed incomes such as pensioners
It destroys the value of cash and discourages saving
It can lead to workers demanding higher wages, creating “wage-price spiral” of further inflation
It can increase the cost of borrowing, adding to financial pressures on households and businesses
Because future costs are hard to plan for, it can deter businesses from investing
It can reduce the value of a currency against other currencies, making imports more costly
It can add to government costs and borrowing, as more provision may need to be made for pensions and other spending
In the worst cases, countries suffering from high inflation have to abandon their local curr