What is inflation and how does it affect interest rates?

Inflation is the rising of prices over time, which in turn decreases the value of currency. A small amount of inflation is good for the economy (2% is generally considered to be the ideal) but too much will result in wide-spread consequences.

Interest rate is the cost that comes with borrowing money. When the inflation rate rises, interest rates tend to follow suit – this is because central banks use interest rate increases to curb inflation and buffer the impact on the country’s economy. Higher interest rates discourage spending and encourage saving.

What is the current economic situation in the UK?

The inflation rate in the UK reached 9% in April 2022. A number of factors have contributed to this substantial increase, including rising energy prices, global supply chain disruptions and increased supply costs in general causing higher prices for consumers.

The impact of inflation will be felt across the country at varying degrees – for example, individuals with fixed incomes, such as pensioners, are more likely to experience the adverse effects of inflation than other people.

Earlier this month, the Bank of England increased the national interest rate to 1.25%. Unfortunately UK inflation has reached such heights that the real rate of return (the inflation rate deducted from the investment rate) is negative, which means the value of your investments is decreasing.

How could higher interest rates affect me?

  • Mortgages. If you have a fixed mortgage rate, you will not be immediately affected but could face a higher rate once your fixed contract expires. If you are on a standard variable rate (SVR) or have a tracker deal, your monthly repayments are likely to increase.
  • Loans and credit cards. As inflation means reduced borrowing power, the amount of interest you pay on loan and credit card repayments may increase.
  • Stock market. Typically the value of shares on the stock market tend to fall as a result of high inflation, as rising inflation indicates an unstable economy and consequently financial uncertainty. Currently, stock performances are very much dependent on sector – growth stocks (e.g. technology) have nose-dived but value stocks (e.g. mining and natural resources) have improved.

How can I protect my assets?

Our primary advice is do not panic. Avoid making any rushed decisions and ensure that every decision you make is underpinned by effective financial planning.

In a volatile economic environment, it may seem tempting to withdraw investments but long-term investments hold less risk than shorter term ones and are therefore more likely to reap financial rewards in time.

If you’re looking to make new investments, opt for value stocks rather than growth stocks for more stable levels of demand and therefore lower chances of costly price collapses.

Ultimately, the best way to protect your assets is to seek specialist support from a wealth management expert.

When it comes to your personal finances, generalisations are useless. Our wealth management experts will work with you to understand your unique financial DNA and deliver bespoke advice on how to react (or not react) to the constantly changing conditions of our economic environment.

Contact us today to speak with one of our financial planners and find out more about our comprehensive private client services.