Investments: What are the impacts of decreasing inflation?

Investments: What are the impacts of decreasing inflation?

Following a peak inflation rate of 11% in 2022¹, the latest figures from the Office for National Statistics (ONS) show that the UK rate has now fallen to 3.2%². For over a year now, inflation has been on a continuous downward trajectory, but is falling inflation always a good thing, and what does it mean for investors?

When looking at the direction of inflation on investment portfolios, it is important to note that a decreasing rate should not be misconstrued as deflation. At the moment, despite inflation’s decline to 3.2%, prices are still rising at a higher rate than the Bank of England (BOE) considers optimal. The BOE targets 2%, which it believes is necessary for economic growth.

Whilst inflation is currently decreasing, investors should be aware that potential risks remain. For instance, in the USA, continuing labour market pressures may cause inflation to be less predictable than anticipated by much of the market.

Impacts of decreasing inflation

It’s beneficial to know the impact of this downward trajectory and the effect it could have on portfolios, so we explore this below:

1. Stabilising prices

Decreasing inflation provides some sort of price stability. That’s always better for businesses, which can struggle when costs escalate at an unaffordable rate. More stable prices allow businesses to perform more accurate cashflow forecasting as their costs won’t change drastically. This puts them in a better place to plan for future investment, making long-term growth of their business more likely. For investors, an improving backdrop for businesses means investments are more likely to grow.

2. Rate cuts

For central banks, decreasing inflation makes it more likely that there will be rate cuts. Central banks will cut rates to stimulate economic activity. This is largely good news for businesses as lower rates lead to more affordable investments, potentially enabling growth. Lower interest rates also encourage more consumer spending and borrowing, further increasing revenues for businesses. As a result of these factors, markets in general tend to respond positively to interest rate cuts.

3. Fixed income

For fixed income investors, lower rates shrink yields on existing bonds, benefiting those with a portion of their portfolio in this asset class as the value of their assets rise.

4. Equities

Due to lower savings rates, investing in equities becomes a better way to achieve higher returns. Investors may find that dividend-paying stocks and income-generating strategies become more attractive, particularly when compared to the current return on cash. Furthermore, in a lower inflation environment, dividend growth becomes a valuable avenue for enhancing returns and lower rates make it easier for companies to finance their growth.

Take a long-term view

The above impacts sound promising but it’s important not to get carried away. Despite news of decreasing inflation potentially causing a lowering of rates, it is still wise to take a considered, long-term view of the markets. This approach is particularly appropriate at the moment as, although the path of inflation seems to be coming down on a global scale, its short-term numbers are volatile.

We are here to help

For further information on what decreasing inflation could mean for your investments, or to discuss your specific situation, please get in touch with a member of our specialist team.

[1] Office for National Statistics: UK Consumer Price Inflation October 2022 (ons.gov.uk)

[2] Office for National Statistics: UK Consumer Price Inflation March 2024 (ons.gov.uk)

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Information correct at time of publishing, but may be subject to change in future. This article is for general information only and is not intended to be advice to any specific person. You are recommended to seek professional advice before taking or refraining from taking action on the basis of the contents of this article.

Azets Wealth Management is a trading name of Azets Wealth Management Limited, which is authorised and regulated by the Financial Conduct Authority. Registered Office: Bulman House, Regent Centre, Gosforth, Newcastle upon Tyne, NE3 3LS. Company Number 05674020. Incorporated in England. Azets Wealth Management Limited is a subsidiary of Azets Holdings Limited.