A popular topic that has been on everyone’s radar over the last few months is inflation. Having reached a record 30-year peak, inflation has been impacting people in many ways, from soaring food and energy bills to economic uncertainty and anxiety amongst businesses and investors. Here at Propiteer Capital, we want to dive into this subject and answer some popular questions such as what inflation is and what its causes are, and how to profit from it, presenting a complete guide on how to navigate and adapt to rising costs.
What is inflation and what are its causes?
Inflation is the rate at which the cost of goods and services increases over time. In the UK, the current inflation rate is 7%, that’s 5% above the Bank of England’s target. This means that the average cost of goods is now 7% higher than it was this time last year. For example, if a pint of milk cost £1 a year ago, that same pint now costs £1.07.
The rate of inflation is typically calculated by determining an annual average. This is carried out by the Office for National Statistics which collects data on the price of hundreds of items to work out the Consumer Price Index (CPI). CPI is then used to set the inflation target.
As the economy overheats and demand for various goods and services increases, we see inflation strike, causing higher prices. A current example of a contributing factor to high inflation is the Ukrainian invasion. The sudden and severe social changes have impacted global oil prices, causing petrol and energy bills to soar. The Covid-19 pandemic is undoubtedly another reason impacting rising prices, but perhaps not to the same extent. While many industries suffered during lockdowns over the last two years, there have been several instances of consumer spending confidence and government initiatives to help those businesses start to recover.
Historically, inflation has increased during and post-major wars, as shown below.
Looking at a period of one year after the end of a war and the end of a major pandemic, the effects of war on inflation have typically been more severe. While inflation surged to 8% post-war, it fell below zero post-pandemic and fluctuated at low levels thereafter. In current terms, a similar trend can be spotted as the World Bank warns of the “largest commodity shock” since the ’70s, with prices set to rise by more than 50%.
Types of inflation
There are normally 3 types of inflation that occur under different economic circumstances: demand-pull, cost-push, and built-in inflation.
1. Demand-pull inflation
When consumer demand outweighs supply, demand-pull inflation arises, leading to a higher cost of goods and living. Some of the causes of demand-pull inflation can include:
· Rapid economic growth
As consumer confidence grows and shoppers have more disposable income, prices increase along with demand.
· Government spending
Prices can rise when government spending goes up.
· Anticipating inflation
Companies can raise their prices in anticipation of inflation. As they expect to incur higher business costs, their cost of goods or services may go up in advance.
· Increased export demand
As goods are traded outside of the country, currencies can experience inflation if the demand for export services grows.
An example of demand-pull inflation is the UK stamp duty holiday in 2021, which saw the volume of property purchases climb. To help the property market recover from pandemic pressures, the government introduced lower or no stamp duty for over a year. As a result of homebuyers taking advantage of the scheme, demand increased and so did property prices. The average property price grew by 8%, and, in some areas, by over 20%, but a gap in supply remained.
2. Cost-push inflation
Cost-push inflation happens when production costs increase. However, as demand stays the same, businesses pass the additional costs onto consumers to compensate and help maintain their profit margins.
The recent rise in the cost of living, and in particular energy costs, is a prime example of cost-push inflation. The demand for gas and electricity supply remains the same, but the reduced supply due to the Ukrainian invasion means that prices for consumers go up as energy has become more expensive for companies to obtain.
3. Built-in inflation
Normally triggered by either continuous demand-pull or cost-push inflation, built-in inflation happens as wages are expected to increase accordingly to maintain the cost of living for workers. However, higher wages lead to higher production costs, which leads to a higher cost of goods, and this is where the cycle begins.
In the UK, inflation is currently outpacing the rise in wages as shown in the graph below.
In the UK, inflation is currently outpacing the rise in wages as shown in the graph below. Either wages will have to increase or inflation will have to drop in order for living standards to be maintained.
Earnings have grown by over 4% in the first 3 months of 2022 versus the same period last year and the inflation rate was 6.2% at the same time. While the relationship between the two is on the right track, prices are continuing to rise, and so built-in inflation is caused. This means that salary demands may also continue for living standards to keep up with the rate of inflation.
Who profits from inflation?
While escalating prices can have a negative impact on consumers, there is some good news for investors that have bought inflation-beating assets. Those with energy stocks or properties in the right locations, for example, might see the value of those assets rise in the current economic climate. Energy and oil are now highly valuable as the industry experiences cost-push inflation, pushing stock prices higher, and the real estate market is seeing demand-pull inflation with homes selling faster than ever even after the end of the stamp duty relaxation last year and larger household bills in recent months. Although the imbalance between those selling and those buying remains, asking prices have also hit record highs, presenting a particular advantage if you’re ready to sell.
There are also opportunities for private rental landlords in times of high inflation as rent prices rise. The below data shows the annual rental increase by region in the UK.
The average rent grew by over 8% by the end of 2021 as demand for rental properties remains. Areas with the largest growth include London and Northern Ireland, so property investors with assets in these developing locations could be seeing new prospects for profit.
Some other investment areas which can benefit from inflation are index-linked stocks or bonds, which perform alongside the rate of inflation, or companies meeting consumer demand by adapting to new or growing needs amongst buyers, such as discount retailers. So, from an investment perspective, inflation isn’t always bad news – as long as you’re invested wisely. There are several ways to make gains from inflationary assets, and if you have a diverse portfolio, this can be a useful way to help spread risk while maintaining profit opportunities.
How you can profit from inflation
Despite the current inflation spikes, which are expected to continue throughout the year, there are many ways to profit from inflation if those inflation-resilient investments are approached correctly. Among others, one asset class that has the potential to benefit from high inflation is property, and there are many ways to become invested in this sector, giving you the flexibility to work with your goals.
If you’re not yet invested in property, there are potential advantages to adding new asset classes to your portfolio, and diversifying investment types can help spread volatility and maintain a healthy correlation between assets during times of high inflation. If you are already invested in the property market, there are options and ways to diversify further, which can open new profit opportunities. For example, if you own physical property, you could consider an alternative location such as those which have seen high levels of price and demand growth, or a different property type or size to service a new and growing target market.
Alternatively, if managing more property isn’t the right choice for you, you could explore indirect property investments such as bonds. At Propiteer Capital, we offer a selection of listed bonds, which are backed by a range of asset classes in the property sector. Each class is dedicated to obtaining high-demand and high-quality developments in profitable locations. The details of the asset classes are:
· Renting of completed buy-to-let apartments
· Popular locations in transient cities
· Purpose-built quality living units
· Acquisition decisions based on rental income
· Recession-resilient asset class
· Occupancy delivered from Hilton and Marriott booking engines with 230 million members combined
· High-demand locations
· Up to 20 years’ regional exclusivity per hotel
· Ultra-efficient ‘focused service’ models for higher profits
· Both hotel brands have 7 ‘focused service’ sub-brands to help target each geographical region
· Build-to-sell projects completed and sold to release development profits
· Cover UK’s most robust locations
· A Private Rental Scheme running in Dublin, Europe’s fastest-growing economy with unit values based on rent
· Robust against inflation via quality properties within the London halo effect and high demand growth regions
· Private rental schemes valued on high yields and become more popular during recessions
Our fixed-rate return rates range between 4.5% and 9.5% and minimum term times start at just 12 months, ranging up to 10 years, giving you the flexibility to work with your short or long-term investment goals.
If you are looking for an inflation-beating investment class that benefits from increasing rental values and improving asset prices, contact us today.
Rates are accurate at the date of publishing. For our latest rates, please visit our homepage.
Recommended Read: How Interest Rates Will Impact the Buy-to-Let Investor