A low inflation rate is usually cause for celebration among savers. But experts are warning that the dramatic fall announced by the Office for National Statistics last week could have a sting in the tail for millions of stock market investors.
Inflation on the Consumer Price Index has dropped from 1 per cent in July to just 0.2 per cent in August – mainly due to Chancellor Rishi Sunak’s popular eat out to help out scheme.
The 100 million discounted meals meant restaurant prices were recorded as lower than a year earlier – the first time that has happened for more than three decades.
Sting in the tail: Low inflation also reduces the chances of an interest rate hike by the Bank of England, which raises rates when it wants to keep runaway inflation in check
The good news for savers is that 661 accounts now beat the 0.2 per cent inflation rate – meaning your money is growing in real terms.
But low inflation also reduces the chances of an interest rate hike by the Bank of England, which raises rates when it wants to keep runaway inflation in check.
And last week the Bank did not rule out the 0.1 per cent Base Rate going negative in the future.
A long period of low inflation and rock-bottom rates could prove to be bad news for stock markets in the UK, experts say.
And that is exactly what Alistair McQueen, head of savings and retirement at Aviva, is now predicting. He says: ‘Much in life feels uncertain these days, but one thing that seems certain for the foreseeable future is a prolonged period of low inflation and interest rates.’
‘This is good news for those seeking to borrow and budget – but for those wanting to save, and live off those savings, times are tough,’ McQueen adds.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, warns that if low inflation sets in for the longer-term, it can have a dampening effect on the share prices. ‘Persistently low inflation can have a negative impact on shares, as falling prices over a significant period of time are likely to damage bottom-line corporate income,’ she explains.
‘There can be a spiralling effect too, as deflation might encourage consumers to put off purchases, save money and reduce spending, denting company revenues further and having an impact on dividends.’
So how should investors react? Streeter says it might be worth turning to firms with huge cash balances such as the technology giant Apple. ‘Companies sitting on a lot of cash are more immune to the risks of falling prices,’ she says.
‘You could also consider firms offering ‘value’ products and services. These may hold up better during a deflationary period, a s consumers tend to trade down when times are tough.’
Teodor Dilov, fund analyst at interactive investor, says: ‘For investors who are worried about the general market, gold can act as a haven.’ He recommends iShares Physical Gold ETC, which aims to track the daily spot price of gold and physically invests in the metal.
For income-seekers, the hunt for returns is only getting tougher. Many FTSE 100 firms have reduced or even suspended dividend payments this year as profits have been hit. It’s unclear when those payments will return.
Top dividend payers now include insurers Aviva and M&G, as well as tobacco firms Imperial Brands and BAT.
Traditionally, income seekers can also turn to government and corporate bonds to provide a steady return. However, yields are already low and near-zero inflation will keep them suppressed.
Roger Clarke, partner at The Private Office chartered financial planners, explains: ‘Low inflation has a knock-on effect down the line on how much interest – called the coupon – you will be able to get from bonds, as they do not have to offer much to beat what banks and building societies are offering, which makes for a very low yield.’
While yields from bonds and shares remain low, investors may want to reassess how much they’re drawing down from their portfolios to avoid rapidly eroding their capital.
Clarke has one strategy that may help investors ride out what could be months or years of low income. ‘One option is to divide your portfolio into several portfolios – the low risk portion you might access in the short-term, while the higher-risk you’ll leave for the longer-term,’ he says. ‘If you manage it well you can avoid the damaging effect of cashing in when markets are low.