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Inflation rises (again): Is it time to sell your shares?

Karl 23rd Mar 2023 No Comments

Reading Time: 6 minutes

The latest inflation figures are in. According to the Office for National Statistics’ Consumer Price Index, inflation rose by 10.4% in the 12 months to February 2023. That’s up from 10.1% in January.

Despite what some political figures may want you to believe, the prices of everyday goods and services are becoming more, and more expensive.

So given the current situation, is it time to move your money out of the stock market and into some inflation-resistant assets?

In this article, we’re going to explore how inflation can impact the value of stocks and shares, and ask the question of whether it’s worth offloading your investments right now. Keep on reading for all of the details, or click on a link to head straight to a section…

In brief: What is inflation?

Inflation is the rate at which prices are rising by. The Bank of England has a target to ensure prices don’t rise by more than 2%. However, over the past few years it has failed to get anywhere near this target.

Right now UK inflation is officially running at 10.4%. That’s more than FIVE times the Bank of England’s target. So, £10 of goods bought a year ago, will only get you £9-ish worth of goods today. And it’s possible things could worsen.

Contrary to common belief, a small rate inflation can actually be a good thing. That’s because it contributes towards economic stability and can encourage people to save, and invest their money.

However, when the rate gets out of control this is where problems can start.

So, what causes inflation? Well, inflation mainly arises when the Government prints money out of thin air. This is known as ‘quantitative easing’ and we saw lots, and lots of it in response to the Covid-19 pandemic. Anyone who understands the link between money printing and rising inflation shouldn’t be surprised at the current rate of inflation we’re seeing right now. The Bank of England shouldn’t either. Despite this, the UK’s central bank, and the Government, often point towards the Ukraine war as the primary factor behind the pain being felt in our pockets.

Of course, there’s no doubt the conflict in Ukraine isn’t helping to combat inflation. However, let’s not forget that the UK was experiencing rising prices well before February 2022 when Russia began its invasion.

To learn more about this, take a look Tim Price’s recent inflation article.

How is INFLATION measured?

It’s really important to understand that the inflation rate is often high politicised. That’s because when prices are rising, it often goes hand in hand with economic mismanagement. This can be an easy win for the opposition!

The political nature of inflation is why some would argue the Government has an incentive to suggest prices are rising by a lower amount than they really are. Money Magpie, CEO, Jasmine Birtles, has previously cast doubt on the official inflation figures. For example, we can see with our own eyes how frequently prices are rising in our local supermarkets.

Now, we’re not suggesting the Government is outright lying to us. We are however suggesting the Consumer Price Index (CPI), the Government’s preffered method of measuring inflation, is probably not the most reliable.

The CPI is calculated by measuring price rises of a ‘typical basket of goods’ and items can be added or taken out at will. Many suggest this basket doesn’t truly capture the true extent by which prices are rising by – either because the basket isn’t large enough, or because the statisticians at the ONS can cherry pick what’s in it.

Also, the CPI doesn’t measure changes in house prices, nor does it take into account council tax rises. These are just some of the reasons why many dislike relying on the CPI as a measure of inflation. Instead, some argue that the Government should use the Retail Prices Index instead. The RPI almost always reports a much higher inflationary figure than the CPI.

In fact, the Government only relies on the RPI when it comes to working out the annual rise in train fares, or to calculate student loans interest! That’s a topic for another day though.

can the government reverse inflation?

Regardless of how you measure it, it’s no secret that inflation is continuing to rise. And yes, the Government can at least try to combat inflation by committing to anti-inflationary policies. The recent budget was an example of this.

Last week, the Chancellor stayed away from announcing big tax giveaways to avoid stoking the inflation fire. Yes, pension tax changes were announced, but this will only impact a few wealthy retirees. However, the Chancellor will probably have to continue this Scrooge-like demeanour if he is serious about getting inflation under control.

In terms of the Bank of England, it too can try to combat inflation. The most obvious way to do this is to raise interest rates. However, raising interest rates isn’t without risk.

Across the pond, we’ve seen two major US banks bite the dust in recent weeks due the the inability of these financial institutions unable to cope with anything other than rock-bottom rates. And what happens in the US can also happen here in the UK. This is why the Bank of England will have to balance its keenness to raise rates with the wider impact on the economy.

You may also have heard of ‘quantitative tightening’. This is essentially the opposite of quantitative easing (money printing), and is a policy that decreases the amount of currency in circulation. While quantitative tightening can help to combat rising inflation, the process can also have an adverse impact on the economy, mostly because there are many businesses hugely reliant on access to cheap credit.

All in all, the current inflation situation is far from pretty and is unlikely to solved without a lot of pain. Who feels this pain, of course, remains to be seen. Will it be the big banks, or the average Joe?

how does inflation impact the stock market?

When inflation runs in the ‘normal range’ of between 1% and 3%, then this can be considered healthy for stocks. As covered above, low, stable inflation creates an predictable environment for both businesses and consumers. This is very much a win-win. Businesses can have faith in their investment decisions, while consumers can be confident everyday prices won’t rise in the short-term.

High inflation, on the other hand, can cause a lot of uncertainty. This is one reason why we’ve seen the stock market suffer experience volatility over the past year or so. High inflation is worrisome for businesses as it makes it very difficult to make decisions for the future. This is why many firms are often reluctant to invest during periods of high inflation.

Likewise, consumer confidence can be shot during high inflation, decreasing their desire to make frivolous or luxurious purchases.

So, now we’ve covered the potential impact of high inflation on the economy, it’s easy to see how the unpredictable nature of rising prices can be bad for the stock market. You see, when inflation is high, interest rates typically rise. This raises the cost of borrowing for businesses, which can hamper any plans for growth. Likewise, stocks can also suffer during high inflation due to the impact on consumer spending.

recent Performance of the FTSE 100

Anyone who has invested in the FTSE 100 will know full well how rising inflation can negatively impact returns. The UK’s biggest share index is barely 1% higher than a year ago, which is a significant fall in real terms.

And despite a promising start to the year, the FTSE 100 is now down 0.06% since 2023 started (at the time of writing).

High inflation: Is now the time to move away from stocks?

Given the sluggish performance of the stock market over the past 12 months, you’ll be forgiven for thinking that it’s time to sell any investments you have in stocks, especially as inflation continues to rise.

Yet before you head to your chosen investment broker, it’s important to consider that the most effective way to invest is to think long-term.

Put simply, when you have a long-term investing mindset, you don’t think about selling stocks just because the economy has a bleak feel about it. With a long-term outlook, you simply continue investing whatever the weather, with the hope that, over time, your investments will outperform other assets, such as cash.

Speaking of cash, selling your shares and stashing your money in the bank probably isn’t the wisest idea right now. While savings rates are rising, interest rates are still nowhere near the current rate of inflation. For example, even the top easy-access saving accounts are offering less than 3.5% right now.

Of course, there are asset classes out there that are known for being decent hedges against inflation. Gold, and other commodities – such as electricity, oil, natural gas, wheat – to name a few. However, if you decide to sell your shares right now you could be crystallising a loss. To put it another way, reacting to news isn’t always the most effective strategy.

Instead, if you’re worried about inflation, then putting part of your wealth in alternative assets could be a decent way to diversify your investments.  However, again, it’s probably best to do this as part of a wider investing strategy – and not just because you’ve a hunch that the stock market will continue to stutter amid high inflation.

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Disclaimer: MoneyMagpie is not a licensed financial advisor. Information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This isn’t financial advice. Anyone thinking of investing should conduct their own due diligence. 

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Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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