The effect of inflation on savings when interest rates are low
As inflation is likely to rise and interest rates may fall further, Investment Manager William Forsyth offers some comfort for those looking for solid investment returns.
One side effect of the Brexit referendum, and the sharp devaluation of Sterling, is the increasing likelihood that inflation will rise next year.
Last month my colleague, James Rae, made some suggestions about how income returns could be supplemented in the current minimal yield environment.
The prospect of inflation adds a further sense of urgency to protecting and enhancing your current level of income from cash and other low-yielding assets, as you attempt to combat the silent erosion of spending power.
City forecasters now believe that inflation will rise to 3% and perhaps a bit more next year.
This point was underlined recently in the “Marmite” pricing dispute between Tesco and Unilever.
Whilst only the two companies can know the exact facts of the case, Unilever anticipated that the cost of buying raw materials would increase in Sterling terms. Tesco could see the effect that this would have on inflating their prices, and resisted strongly, fearing the impact on their customers.
While the dispute seems to have been settled, commentators have raised this as a sign of inflation trends next year.
Help from the authorities?
As the economy slows, with a forecast growth rate next year of around 1%, with the potential complexities of Brexit becoming clearer, the Bank of England is looking to assist industry by cutting official interest rates again.
Whilst any reduction from an already miserable bank rate of 0.25% is more symbolic than noticeable to private individuals, it is a further sign that interest rates are likely to remain low for the foreseeable future.
How safe is safe?
The irony is that the strongest covenant available in the income world may not be a secure home for your funds.
Gilts or British Government securities have recently fallen in value as foreign investors have demanded a higher return on their money. This means that the higher yielding securities may have theoretically less secure backers, but may, in fact, offer more generous and less volatile returns.
The quest for real returns
The good news is that the distortion caused by many investors insisting on Sovereign bonds in the UK and elsewhere means that there are many fixed interest and similarly defensive investments available.
These investments offer immediate and prospective real returns - even if inflation moves up to 3% next year.
We previously mentioned a variety of investments such as Infrastructure and Renewable fund investments, where yields of 5% or so could be achieved offering a clear premium on current and anticipated levels of inflation.
However, we also believe that protection against the inflationary impact of inflation on capital is possible. The investment property market has shown greater stability post Brexit, and with the underlying link to the equity value of buildings, this should prove helpful too.
Inflation-linked investments can also protect capital as well as income for the long term. A final option of a careful selection of equity investments can be considered for a minority portion of the portfolio to add balance and, with care, solid real returns over time.
About the author
William Forsyth is an Investment Manager at ‘Charlotte Square’ an investment management boutique situated in the heart of Scotland’s financial centre and offering a highly personalised discretionary investment management service for a range of private clients, trusts, pension schemes, corporate funds and charities. He is a Chartered Fellow of the Chartered Institute for Securities and Investments (CISI) and is a founder of the business.
To find out more please contact WForsyth@charlotte.eu.com
About the company
Charlotte Square is a trade name of Raymond James Investment Services Ltd (Raymond James) utilised under exclusive licence. Raymond James is authorised and regulated by the Financial Conduct Authority. With investment, your capital is at risk. The price of investments and the income from them can go down as well as up and neither is guaranteed. Nothing contained in this article constitutes investment, legal, tax, regulatory or other advice, nor should be relied upon in making an investment or other decision.
This blog is one of a series of articles from our commercial partners.
The views expressed are those of the author and not necessarily those of ICAS.