Inflation is at a 40-year high. Does this mean that it is a good or a bad time to invest? Broadly speaking, the best strategy is one of ‘time’ in the markets rather than ‘timing’ the markets as investors seek a more balanced approach. 

Historically, when inflation is high, stocks have performed strongly directly after the inflation rate has peaked. However, stocks have shown relatively weak performance during the periods of high climbing inflation. Currently, inflation is continuing to rise, with the consumer price index (CPI) which broadly measures the prices of goods and services now at 9.4% in the U.K. (to June 2022). This represented a rise of 0.30% on the previous month and has largely been driven by food and fuel costs.

So when will inflation peak? This is notoriously difficult to predict and we will only know for sure looking backwards i.e. after the event. When inflation is lower, changes to the inflation rate don't tend to have too much of an impact on the markets. The markets, however, do tend to become rather more sensitive to inflation once the rate exceeds circa 4%.

When inflation is high, the central banks (e.g. The Bank of England, The European Central Bank, The Federal Reserve and The Bank of Japan etc) tend to raise interest rates because higher rates can make it more difficult for businesses and consumers to borrow and spend money, which can in turn help slow demand and thus challenge rising prices. However, it can also negatively impact stock market prices and that can make investors fearful.  

Alternately, when inflation is low, investors tend to worry about a weakening economy and what that means for companies' earnings and stock prices. As the inflation rates accelerate, stocks can do better, but then it doesn't take long before too much inflation has a detrimental effect on the stock market.

These are all part of the reasons why the inflation rate's peak is so important to investors. When inflation rises, investors are more pessimistic and inclined to keep their money in reserve. Stock prices fall on these concerns, and when inflation moderates, this can present a buying opportunity. The influx of cash then boosts stock prices higher. It is rare to have inflation this high and if we are nearing the peak, this could be a buying opportunity.

Advice and finding the right approach for you

A challenging economic situation is a practical time for investors to gauge if their financial risk tolerance is right for them. Some people may have invested too adventurously or too cautiously and then discover during market volatility that their emotions get the better of them. It is therefore important to find the right balance to keep investing over the long term because if you want to build a nest egg and you want to grow your money over time, you will need to be invested in areas other than a savings account. The amount and detail of alternative options to cash available can be daunting and therefore receiving advice may prove to be a valuable addition to your strategy in helping you to achieve your goals.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.

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