Inflation is at its highest in decades, with the U.K. inflation rate reaching a high of 11.1 percent in October 2022, up from 10.1 percent in September. Surging housing costs were the biggest contributor to inflation last month, rising 26.6 percent compared to last year. In 2022, the annual inflation rate for the United Kingdom is expected to reach 9.1 percent before falling to 7.4 percent in 2023 and 0.6 percent in 2024[1].
Find out here what consumers should expect now and what experts say about the medium-term inflation outlook.
High inflation: investments with Xtrackers ETFs
Core ETFs - equities as a solid component for your portfolio
Forecasts for global consumer prices
Global inflation is forecast to reach 8.4 percent in 2022; rising energy costs[2] in particular continue to cause uncertainty as to how the inflation rate will develop further. Currently, the global inflation rate is expected to fall to 4.14 percent by 2027[3] . The annual inflation rate of the consumer price index in the UK is forecast at 1.7% in 2027[4] .
Current key interest rate in the UK
The Bank of England raised its key interest rate by 0.5 percentage points to 2.25% in September 2022. It was the highest level in the UK since the financial crisis of 2008. In November, the British central bank increased its key interest rate by another 0.75 points and now stands at three percent. This is the most significant increase in 33 years. According to experts, the currently increasing key interest rate in the United Kingdom could hit property owners in particular whose fixed-rate contracts are expiring. The reason: mortgages account for the largest share of private household debt, and interest rates on them could rise soon.[5].
Financial investments in comparison
What impact can high inflation have on savings accounts and fixed-income securities? And what impact do rising consumer prices have on inflation-linked bond ETFs? For a comparison of the risk and return of overnight deposit accounts, nominal government bonds and bonds with a floating rate, see the table below.
| Savings account / Overnight account | Nominal Government Bonds | Inflation Linked Bonds | |
|---|---|---|---|
| Effect of high inflation | Significantly higher inflation can lead to negative interest rates on savings accounts and overnight deposit accounts | The nominal yield on a government bond (fixed-income security) is negatively impacted by high inflation, so the real yield also decreases over the investment period | Compared to an investment with a fixed nominal return, ETFs with Inflation Linked Bonds can be an alternative if inflation is higher in the future than expected by the market |
| Risk | National Deposit Protection: deposits and accrued interest are protected in the UK up to a total of £85,000 per customer per bank | Xtrackers ETFs have no capital protection and are not guaranteed. | |
| Yield | Negative yield → "Zero interest rates" lead to a negative return on the savings account |
Lower yield → Purchasing power of interest coupon and redemption amount decrease |
Average yield → Could benefit from the cost-average effect with long-term investments in inflation linked bonds |
What factors increase the inflation rate?
Both constructive and destructive factors can contribute to consumer prices rising and the value of money falling. These include:
- Constructive factors, e.g., a tight labor market / uncertain market phases → economic (cyclical) causes.
- Destructive factors, e.g. supply chain problems / supply shortages or rising energy prices → (monetary) political causes.
Due to constructive and destructive factors, additional, unpredictable inflation developments could arise; in this case, it's also called ‘uncontrolled inflation‘[6].
Constructive inflation: the macroeconomic background
If the macroeconomic situation improves, a country's economy develops in a 'growth-oriented’ manner; if the macroeconomic situation deteriorates, it is referred to as ‘subdued growth’. Both scenarios lead to an above-average realised or actual inflation rate.
Usually, bonds generate comparatively lower returns than equities in times of positive economic growth. Due to the average cost effect, over the long term, inflation-linked bonds can therefore be an option in times of sustained rising consumer prices. In the medium term, however, fixed income and high-yield bonds [DISCLAIMER:High-yield bonds typically have a higher risk of default but offer higher yields compared to investment-grade bonds.]] also offer a way of offsetting inflationary scenarios.
| Xtrackers Bond ETFs - alternative investments in case of high inflation | Xtrackers Government Bond ETFs - fixed income securities | Xtrackers High Yield Bonds - comparatively high dividend payments |
|---|---|---|
| Product offering | Product offering |
Destructive factors: the role of central banks
Central bank policies have a decisive influence on the extent to which actual inflation is reflected in the macroeconomic situation. Generally speaking, if market sentiment improves, stocks such as value stocks[7] or investments in emerging markets perform best; if stock market sentiments decrease, inflation winners are normally bonds or long-term investments in fixed-income securities.
In a scenario where inflation and economic growth move in opposite directions, so-called safe haven[8] investments could be an option to invest money. These include, among other things, investments in gold or investments in foreign currencies such as Swiss francs or USD. If the yield and price move inversely to each other, i.e. if the yield on a bond falls while the price rises, investments with a short-term maturity could offer further advantages in terms of total return. Especially when real interest rates reach new lows, this aspect could become important for investors[9].
| Xtrackers Gold ETCs - solid options with low real interest rates | Xtrackers EM-ETFs - investing in emerging markets | Xtrackers Short Bonds - invests with short maturities (duration) |
|---|---|---|
| Product offering | Product offering |
Uncontrolled inflation: price stability before economic growth
If central banks are raising interest rates despite a negative economic outlook, uncontrolled inflation may occur as many market participants expect a bear market[10]. Government and corporate bonds will then be affected by higher interest rates, so equity markets with high valuations could be particularly at risk. The reason: higher interest rates can also lead to higher discounting[11] of expected profits. However, in this worst-case scenario, inflation linked bonds could be an alternative option to diversify the portfolio.
All Xtrackers inflation-linked Bond ETFs Forecast for Bond ETFs
Xtrackers investment solutions for inflation scenarios
| Options from Xtrackers | Factors that benefit an increasing inflation rate | Investment focus | ||
|---|---|---|---|---|
| Constructive factors | Destructive factors | Not predictable | ||
| Short Duration Bonds | ◉ | Short maturities promote resilience - also under sustainability criteria | ||
| High Yield Bonds | ◉ | Short maturities can counteract negative real interest rates | ||
| Value Stocks Europe | ◉ | Combination of Europe-specific ETFs, cyclical sectors and value factors | ||
| Chinese Government Bond | ◉ | ◉ | Exposure to fixed income with a focus on ‘safe haven’ assets | |
| Minimum Volatility Equities | ◉ | ◉ | Focus on risk diversification and moderate valuations | |
| Inflation Linked Bonds | ◉ | ◉ | Long-term investment with average constant costs | |
Further information
1. Source: statista | as of November 2022
2. Global energy price spikes 1979-2022, by fuel (source: statista.com | as of October 2022)
3. Source: statista.com | as of October 2022
4. Source: statista.com | as of November 2022
5. Source: Deutsche Presse-Agentur (in an interview with economist Michal Stelmach from the auditing and consulting institute KPMG | London, as of November 2022.
6. Source: boerse-frankfurt.de | as of June 2022
7. Value stocks are securities of undervalued companies, i.e., companies that are comparatively cheaply valued but investors expect to see a large increase in value shortly.
8. This refers to investments that could maintain or even increase in value during economic downturns.
9. Source: boerse-frankfurt.de | as of June 2022
10. Economists define a ‘bear market’ as a prolonged decline of at least 20% in a major stock market index, such as the DJIA or S&P 500 (opposite: ‘bull market’).
11. In finance, a discount refers to the right to defer a payment to a later date.