These FTSE stocks could surge with inflation back at 2%

Jon Smith explains several reasons why lower inflation is good for FTSE stocks, and provides examples of those he thinks could outperform.

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Yesterday (19 June), the May reading for UK inflation was released. It showed that inflation is now back at 2%. This is really important because that price level is the target for the Bank of England. It’s the first time in almost three years that we’ve dropped to this level. With my investing hat on, there are some FTSE stocks I think could do very well off the back of this.

Higher revs

The first on my list is Auto Trader (LSE:AUTO). A couple of weeks ago I purchased shares in this business following the release of its full-year results. I was impressed with the continued growth, combined with the stronger prices in the second-hand market.

I think that demand for vehicles should continue to increase over the coming year, thanks to falling inflation. One reason for this is that price pressures should ease on manufacturers, meaning that new cars shouldn’t be prohibitively expensive.

For the secondhand market, lower inflation should also help. I’d expect interest rates to fall, as the battle against inflation has almost been won. Lower interest rates make it easier to get finance on car purchases. It should make people more confident to go out and buy a car (as a large purchase).

With all of this, Auto Trader should reap the benefits as the leading UK vehicle marketplace. Fees for listings and adverts should be boosted.

As a risk, there’s the potential for this theme to be delayed. Some people might still hold back on buying or selling a car as they are still somewhat scarred by the cost-of-living crisis. Therefore, Auto Trader might not feel the financial benefits for some time yet.

Lower funding costs

Another area that could do very well is real estate investment trusts (REITs). These listed stocks invest in property and the value of the portfolio is closely reflected in the share price.

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Naturally, the trusts don’t usually have the cash to buy all the properties. Therefore they borrow money just like I would to part-fund a property. The higher the loan costs, the less profitable the REIT is, as these costs are subtracted from the income made from renting and leasing the locations.

With high inflation, interest rates rose to combat this. Loan costs for REITs shot higher. Yet with inflation now back at the target level, interest rates should fall. This will give REITs lower funding costs, improving their profitability. This should be reflected in higher dividend payments.

Of course, this is the theory. In practice, a REIT might have just locked in to a new loan for the long term. It therefore might not benefit from lower funding rates for some time.

Two trusts that I have on my watchlist are Target Healthcare and Hammerson.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith owns shares in Auto Trader Group Plc. The Motley Fool UK has recommended Auto Trader Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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