Our real spending power is falling

Peter McGahan examines the impact of inflation on our income and investments and warns worse is to come once Brexit bites.

Falling spending power

In simple terms, it is fair to ask why governments might have an upward inflation target. Surely with the advent and simplicity of systems and computers, the world has become easier, and as such we shouldn’t have rising prices? Maybe the target should be to bring down the cost of living?

Over simplification by me?

Whilst their primary objective appears to be price stability, there are many factors that drive inflation, all of which can have a very damaging effect on your standard of living and investments.

I’ve always thought of inflation as a form of ninja austerity, keeping the hamster wheel whizzing around.

The FT announced recently that the value of wages over the next ten years is expected to be the worst for more than 200 years in terms of pay packets, with the average UK worker still likely to earn less in 2021 in real terms than they did in 2008. (1)

Inflation in April sat at 2.7% with average regular pay at 2.1% and the Bank of England has now cut its expectation for wage growth to 2%. (1)

Inflation has the ability to erode our investments and savings and indeed the ability to save at all, and can be a real enemy of the investor if left uncurbed.

Lets take the example of two people born in 1991 and 1951, and their cost of living on the day they were born.

The average weekly spend (£528.90) for a UK household totalled £27,502 last year. (2)

If we backtracked this cost using the Bank of England’s inflationary figures the cost of living would be £13,960 per year in 1991 and in 1951, a staggering £954.10 per year. (3)

So we can easily see why inflation can be the ‘enemy’ and why our capital and income needs to keep treading water, or to help us run on the hamster wheel.

Keeping your income or investments level with inflation forces us into taking some elements of risk, as that’s where the potential for return is.

There is no cake and eat it with investments, and all an experienced manager can do for you is to have the correct insight to minimize loss and maximize gain, as markets fluctuate both up and down, creating that risk and potential reward.

Over the last five years inflation (Retail Price Index (RPI)) has eroded 11.63% of our cash if held under the bed or 7.3% if we use the Consumer Price Index (CPI). (4)

The Bank of England base rate would have returned 2.33%, Halifax Property Index 37.8% and the FTSE All-Share 78.28%, giving you over 66% extra spending over and above inflation. (4)

Going back from 1988 until now, the RPI would have increased by 161.96%, the Bank of England base rate 317.44%, Halifax property index 348.92% and the FTSE All-Share 1216.35%, giving over 1000% extra spending power over the RPI. (4)

It is most notable that investors in the past could have relied on a deposit account to outperform inflation, but those days are gone, for now.

At the heart of it all is the pain of Brexit and its fiasco negotiations, which is driving sterling lower. As sterling drives lower, imports become more expensive.

I’ve heard ‘Brexit hasn’t impacted us’. Well…Brexit hasn’t happened yet, but the impact of sterling is about to nudge on further.

Even a simple example of the divorce bill shows the extraordinary disparity with the FT at €91bn to €113bn; Bruegel the economic think tank €86bn to €113bn; the Institute of Chartered Accountants for England and Wales at £5bn. (5)

The disparity will move more toward a harder Brexit and push hard on sterling and higher inflation.

Meanwhile, as warehouses use up their resources and have to import more, the true cost will become more evident and feed into inflation.

Whilst a falling sterling helps the UK’s export market, (exports become cheaper), the UK is a net importer therefore costs rise. Furthermore, many of the parts used in manufacturing are imported so the products aren’t automatically as competitive.

None of this weighs well on sterling and in turn inflation.

If you have a question on inflation and protecting your investments, call Worldwide Financial Planning on 0800 0112825, email [email protected] or visit us on www.wwfp.net.

Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. 

Last modified: June 10, 2021

Written by 11:44 am News & Views