Home Brokerage As Inflation Falls, Why Are Investors Still So Concerned About Its Impacts?

As Inflation Falls, Why Are Investors Still So Concerned About Its Impacts?

by internationalbanker

By Giles Coghlan, Chief Market Analyst, HYCM





Since the beginning of 2022, the investment landscape has been dominated by the persistent climb in the inflation rate, which has given rise to a host of economic implications with which all policymakers, businesses, consumers and investors have been forced to grapple. With inflation consistently hovering above the 10-percent mark for the majority of 2022 and the initial months of 2023, one of these implications has been the rapid ascent of interest rates, which in the United Kingdom have risen 12 consecutive times to 4.5 percent.

Although recent data revealed that UK inflation declined to single digits (8.7 percent) in April 2023, a closer examination of the data and broader economic landscape shows that many of the factors driving inflation are still exerting their influences on the markets.

Inflation still poses significant risks to investors.

According to new research commissioned by HYCM (online foreign exchange [forex] and contract for difference [CFD] provider), a significant proportion (50 percent) of investors still view inflation as one of the top three risk factors affecting their portfolios, highlighting their prevailing concerns about the potential impacts it could have on their investments.

For instance, a significant majority of investors (56 percent) stated they held the belief that inflation is now ingrained in the economy and will prove challenging to reverse, indicating their lack of faith in the Bank of England’s (BoE’s) interest-rate hiking cycle as an effective measure of controlling inflation. Consequently, only 31 percent of investors believed the UK Government would fulfil its promise of halving inflation this year.

Considering the significant inflationary pressures that remain at large in the economy, such scepticism is understandable. Although there was a decrease of more than 1 percent in the inflation rate in April compared to the previous month, it would be inaccurate to interpret this as a sign that the economy is adequately cooling. Instead, this significant decline can be attributed to what is known as “base effects”, wherein the sharp price increases observed a year ago are no longer factored into the annual comparison.

Consequently, while inflation fell to single digits, this does not imply that prices are actually decreasing; rather, they are merely rising at a slower pace compared to a year ago. Therefore, any optimism investors might have felt from the Consumer Price Index (CPI) reading was swiftly overshadowed by the accompanying data, as well as labour-market data from April.

Indeed, with ongoing tightness in the labour market, April’s wage-growth data exceeded expectations, increasing fears of a dreaded wage-price spiral that could further entrench inflation. As such, with average regular pay increasing by 6.7 percent between January and March 2023, the International Monetary Fund (IMF) recently advised the Bank of England to wait for a decline in wage growth before contemplating a more dovish monetary policy.

Food-price inflation is another cause for concern, which, despite dipping 0.1 percent in April, remains at 19.1 percent, representing the second-highest rate of increase in more than 45 years. This poses a threat to investors in stocks and shares in particular, as consumer spending is likely to be constrained. Consequently, alongside rising operating costs, some businesses will experience further profit-margin squeezes, leading to declines in stock-market valuations.

Meanwhile, core inflation surged to 6.2 percent in April, up from 5.7 percent in March. As such, even as headline inflation falls, prices for most goods and services continue to grow. Such a trend suggests the presence of a more enduring inflationary pattern in the economy, adding weight to investors’ concerns over inflation becoming entrenched. 

The Bank of England will be compelled to take decisive action.

Ahead of the latest CPI data release, BoE Governor Andrew Bailey hinted at the possibility of further base-rate increases should inflationary pressures persist. So, with the headline rate not declining to the extent the markets expected, it is likely that the Monetary Policy Committee (MPC) will feel compelled to take further action to meet its 2-percent target.

Nevertheless, findings from HYCM’s survey revealed that investors harboured concerns about the repercussions of additional interest-rate hikes. A significant proportion (43 percent), for example, expressed their beliefs that the Bank of England should halt its hiking cycle to prevent a banking crisis. The recent failures of Silicon Valley Bank (SVB) and Credit Suisse have played significant roles in shaping investors’ concerns, as they attribute much of the perceived vulnerability within the banking sector to escalating borrowing costs. Consequently, these investors have advocated for a more accommodative monetary policy by the Bank of England.

Likewise, a significant number of investors (44 percent) named slow economic recovery and sluggish growth among their top concerns. This sentiment is understandable, considering the adverse effects on growth already observed from the series of interest-rate hikes over the past 18 months. Notably, the International Monetary Fund projects a meagre 0.4-percent growth rate for the UK economy this year, positioning it as the second-worst performing nation among the G7 (Group of Seven) countries. Therefore, one would expect investors to argue that interest rates have already reached excessive levels, and, therefore, they would not support further hikes.

That said, only a minority (35 percent) of respondents considered the current level of interest rates too high, suggesting that their concerns about the prospect of further rate hikes primarily revolved around apprehensions about the stability of the banking system. On the other hand, despite the potential implications of rising rates on economic growth, investors may view low growth as the preferred scenario compared to inflation’s detrimental impacts.

Consequently, it is highly probable that the Bank of England will move ahead with another base-rate hike this year, particularly as the markets now anticipate that interest rates will peak at 5.5 percent.

How are investors managing their investments in the current climate? 

Considering the aforementioned risk factors, the HYCM survey sheds light on how investors have navigated these challenging economic conditions.

Interestingly, fewer than one-third (30 percent) of respondents reported diversifying their investment portfolios to protect themselves against market volatility. However, a notable 43 percent expressed confidence that their investments would be resilient enough to withstand the impacts of any future market shocks. These investors are possibly remaining composed in the current climate and retaining faith that their investments will ultimately recover over the long term, even if they do experience some losses in the near future.

Meanwhile, 26 percent of investors have chosen to embrace higher risks for their investments in pursuit of higher returns. These investors may also be adopting a “buy the dip” approach, aiming to capitalise on the rebound of currently weakened financial markets. However, it is crucial to recognise the potential consequences associated with assuming additional risks in such an uncertain economic climate.

In summary, it is evident that investors generally express support for additional interest-rate hikes to curb inflation. However, it is equally understandable that they harbour legitimate concerns about the potential impacts of further monetary tightening on the overall economy and the banking system’s stability. Given the unpredictability of current market conditions, it is imperative for investors to make decisions based on their individual circumstances, aligned with their specific needs and goals.

About the research

The market research was carried out between May 1 and 9, 2023, among 2,000 adults in the United Kingdom via an online survey by the independent market-research agency Opinium. Opinium is a member of the Market Research Society’s (MRS) Company Partner Service and strictly adheres to its code of conduct and quality commitment. Its MRS membership means that it adheres to strict guidelines regarding all phases of research, including research design and data collection; communicating with respondents; conducting fieldwork; analysis and reporting; and data storage. The data sample of 2,000 UK adults is fully nationally representative. This means the sample is weighted according to ONS (Office for National Statistics) criteria so that the gender, age, social grade, region and city of each respondent correspond to the UK population as a whole. Within this sample, 914 respondents had investment portfolios worth in excess of £10,000—this includes all assets, from bonds and currencies to commodities and stocks and shares, but excludes any properties used as their primary residences.

(High-risk investment warning: Contracts for difference [CFDs] are complex instruments with high risks of losing money rapidly due to leverage. Seventy-one percent of retail investors’ accounts lose money when trading CFDs with HYCM. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing money. For more information, please refer to HYCM’s Risk Disclosure.)

Disclaimer: Any opinions expressed in this material are personal to the person expressing them and do not reflect the opinions of HYCM. This material is considered marketing communication and should not be construed as containing investment advice or recommendations or as an offer of or solicitation for any transactions in financial instruments. Past performance is not a guarantee or prediction of future performance. HYCM does not take into account your personal investment objectives or financial situation. HYCM makes no representation and assumes no liability as to the accuracy or completeness of the information provided or any loss arising from any investment based on a recommendation, forecast or other information supplied by an employee of HYCM, a third party or otherwise.


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