Inflation is a topic that has been making headlines this year. It’s important to understand how it can impact your savings and investments.

Simply put, inflation refers to the increase in the price of goods and services over time. It means that your money may be able to buy less in the future than it can today.

The Office for National Statistics (ONS) measures inflation by tracking the prices of everyday items to calculate changes in the Consumer Prices Index (CPI).

CPI rose by 6.8% in the 12 months to July 2023. Although this has been falling over 2023, it remains well above the 2.0% target the Bank of England aims for.

Its effects are easy to see any time you go shopping. According to the ONS, the average price of a pint of milk in the UK was 69p in July 2023. This compared to roughly 45p in 2019. Similarly, the price of a loaf of sliced white bread jumped from £1.07 in 2019 to £1.35 in July 2023.

Inflation can be caused by a variety of factors. In this case, inflation started to ramp up as we moved away from the COVID-19 lockdowns. While in lockdown, people were limited in their ability to socialise and visit shops. As restrictions were lifted and consumers became free to leave their homes, they began spending again, leading to a surge in demand. Unfortunately, it has taken longer for the supply side to catch up.

Then Russia’s invasion of Ukraine at the start of 2022 caused further inflationary pressure. Both countries are major suppliers of commodities such as wheat and fuel. With supplies of these interrupted, the cost of both spiked.

Since a peak in late 2022, inflation has gradually come down.

With higher interest rates, will a bank account protect my savings?

When it comes to combating inflation, relying solely on high street banks may not be the most effective strategy.

While banks do offer interest on instant access savings and Cash ISAs, the rates they typically offer may not be enough to keep up with inflation. As a result, the purchasing power of your savings may erode over time, and you may find that your money’s value does not grow at the same rate as inflation.

For example, if you had £10,000 in an account with a 5% saving rate, after a year you will have £10,500. However, if the rate of inflation is also running at 7%, you would need £10,700 to have the same purchasing power that you started with. If your savings don’t grow at the same rate as inflation, your money will lose its purchasing power despite taking active steps to grow it.

The chart below shows the relationship between the Bank of England base rate and CPI. When there’s a wide gap between CPI and the base rate, it becomes challenging to find savings that offer returns above the rate of inflation.

Where investing can help

If you plan on saving over the long term, which typically means for five years or more, then choosing to invest could be the best way to shield your money from the damaging effects of inflation whilst also securing your future financial wellbeing.

However, it’s important to note that investing also comes with risks. You can speak with a financial planner to discuss an investment strategy that matches your risk appetite and investment objectives.

The key to beating inflation is by investing in assets which produce a higher rate of return than inflation. Over the long term, equities have demonstrated the ability to outpace inflation, although that does not necessarily mean this will be repeated.

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Keeping your investments diversified is also crucial to ensuring that you’re not relying too heavily on one particular type of asset class. Diversification involves spreading your investments across asset classes such as equities, bonds, and property.

Different assets may perform differently in different economic conditions. No one asset class will be the best performing forever – so by keeping a diversified portfolio, you can help your investments to remain resilient, even during periods of high inflation.

Please be aware past performance is not indicative of future performance.

The value of an investment will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

Equities do not provide the security of capital which is characteristic of a deposit with a bank or building society.

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