Why you should be worried about inflation

Inflation is set to rise and this could make life more difficult for investors.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

During the last decade, the world has faced the threat of deflation. This has been countered across the developed world by low interest rates and a policy of quantitative easing which has stimulated growth and boosted inflation.

Now, though, the prospects of deflation are falling rapidly and a new threat is emerging. The global economy could face relatively high levels of inflation in 2017 and beyond. And with growth prospects still limited, it could cause a quandary for policymakers across the world.

Higher inflation

A major reason why inflation could increase over the medium term is a shift in policy under the US President. Although there is no certainty as to what his policies will be, Donald Trump looks set to reduce taxes and increase spending. This will cause a widening of the budget deficit and lead to higher rates of inflation in the US.

Similarly, China is also experiencing higher levels of inflation which could get worse in the coming months. Higher commodity prices and rising wages mean that the cost of its manufactured goods is likely to rise in future. With countries across the globe being reliant on Chinese imports since it is the ‘workshop of the world’, global inflation expectations are moving higher.

The response

Theoretically, the response to higher rates of inflation is simple: put in place a more restrictive monetary policy. This will help to cool inflation, although it could take time to have an impact due to time lags.

However, the problem faced by Central Banks across the globe is that economic growth is relatively sluggish. This means that if interest rates are increased then it could have a negative impact on economic growth and lead to a period of stagflation. This is where inflation is relatively high, while economic growth stagnates.

Already, the US has started to increase interest rates. And with the UK and Eurozone experiencing currency weakness, they may be forced to have a higher than desired interest rate as the price level rises.

The impact on investors

As mentioned, rising inflation can cause higher interest rates, which in turn could mean slower economic growth. This clearly causes a major headache for investors, since it could lead to downgrades in earnings forecasts and a reduction in valuations and investor sentiment.

Some companies will be able to cope with higher inflation better than others, which is why it is crucial to seek out stocks with wide economic moats. For example, high levels of customer loyalty or stubbornly low cost bases relative to competitors could mean that the impact of inflation is less negative. Furthermore, a wide margin of safety and a yield which is well ahead of inflation could help stocks to perform better than their peers in future.

High inflation has caused economic turmoil on a number of occasions in the past. While it is not yet at challenging levels, there is the potential for it to move much higher. As such, it may be prudent to plan for its arrival later this year through buying good value stocks which can thrive in a very different global economy to that experienced over the last decade.

More on Investing Articles

Black woman using smartphone at home, watching stock charts.
Investing Articles

2 spectacular growth stocks to consider buying in March

Investors ignore the risks with growth stocks when things are going well. But when this changes, fixating on the dangers…

Read more »

UK financial background: share prices and stock graph overlaid on an image of the Union Jack
Investing Articles

Why is the FTSE 100 suddenly beating the S&P 500?

The UK's blue-chip index has been on fire over the past couple of years, helping it catch up to the…

Read more »

Artillery rocket system aimed to the sky and soldiers at sunset.
Investing Articles

This non-oil FTSE stock’s risen 4.6% in 3 days. What’s going on?

Against the backdrop of trouble in the Middle East, James Beard investigates why this FTSE 100 stock’s doing so well.…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Has a 2026 stock market crash just come a whole lot closer?

If we're in for a stock market crash, what's the best way for us to prepare, and what kinds of…

Read more »

Silhouette of a bull standing on top of a landscape with the sun setting behind it
Investing Articles

Up 79% in a year, this FTSE 250 stock still gets a resounding Strong Buy from analysts

This under-the-radar growth stock in the FTSE 250 has been on fire over the past 12 months. Why are City…

Read more »

Frustrated young white male looking disconsolate while sat on his sofa holding a beer
Investing Articles

Vistry shares down 20%! Here’s what I’m doing…

Vistry shares have crashed as the firm cuts prices and moves away from share buybacks. But is Stephen Wright’s long-term…

Read more »

UK financial background: share prices and stock graph overlaid on an image of the Union Jack
Investing Articles

The IAG share price is climbing today despite war fears – what’s going on?

It's been a tough week for the IAG share price and Harvey Jones expects more volatility. Yet the FTSE 100…

Read more »

Businessman with tablet, waiting at the train station platform
Investing Articles

By March 2027, £1,000 invested in Natwest shares could turn into…

NatWest shares have been on a tear in recent years. What might the next 12 months have in store for…

Read more »