Are concerns about inflation inflated?

Apparently, food inflation is slowing. Yet finding myself at a farmyard deli counter last week (long story), I was shocked by how expensive everything was. £6 for a small packet of oat biscuits! More surprising was just how busy it was on a Tuesday afternoon. The place was mobbed with people jostling for position at the deli counter, and they were not holding back on spending.

Fighting inflation

At the domestic level, the Bank of England interest rate rises are intended to do two things; suppress spending and increase saving.

Neither outcome appears to be working with sufficient force yet. Given my recent observations, these are two possible explanations why not:

• Revenge Spending. This is a psychological phenomenon whereby consumers buy more luxury goods and services than usual after a restricted phase arising due to an unexpected adverse economic event such as a pandemic. As a result, consumers aggressively shop and spend the saved money to compensate for the lost time. An excellent example is the travel industry, which is booming as people are determined to get away and 'to heck' with the cost.
  
  
• Why Save? The banks have been excruciatingly slow in passing on higher rates to savers.  The Bank of England base rate now stands at 5%; the highest level since 2008. Yet the average easy-access savings account pays less than half this level at 2.45%. Proof that banks continue to make hay whether the sun shines or not!

The outlook

These behaviours are just delaying the inevitable. Rates will keep climbing until people run out of road.

The mortgage market is the most obvious place where the rate rises are starting to take effect.  By historical standards, 5% is not that high, but it's the 'speed' of increase that is starting to bite.  The housing market has stagnated, and some areas' prices have started falling.

Is there any good news?

Firstly, inflation can have some hidden benefits. In particular, debt is inflated away over time. For example, a £50,000 mortgage taken out 25 years ago would have felt like a massive sum at the time, but today £50,000 is about one or two years' income for the average household.  We all have stories about our grandparents buying their first home for £250!

Secondly, the US is doing a much better job of getting on top of inflation than the UK. Since US companies represent more than 50% of the global stock market, the US plays a much more important role from an investment perspective than our domestic economics.

Finally, history also shows that stock markets outpace inflation over time. Whilst now is a testing time for all of us, the best plan, as ever, is to sit tight and remain calm.

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