Cost of living crisis: What you need to know

High inflation. Spiraling energy costs. The biggest real-terms fall in incomes since the 1970s.

We are all feeling the impact of the cost-of-living crisis in our pockets each month, but it can be confusing to know exactly why, how long it’s likely to last for and what we can do about it. In a complex environment, we answer the questions our clients want to know.

What is causing the cost-of-living crisis?

It’s a combination of factors which have collided at once, but broadly it can be traced back to the pandemic. Government-mandated lockdowns caused supply chain bottlenecks, which are inflationary because they prevent supply from meeting demand. An exodus of certain workers due to Covid and Brexit also caused labour shortages, which too are inflationary.

When vaccines arrived, the economy rebounded but supply issues endured. Rising oil and gas prices foretold an inflation spike in April 2022 when Ofgem increased the energy price cap. However, Russia invaded Ukraine in February, intensifying the energy crisis further, and China’s zero-Covid policy saw it return to lockdown when cases rose again, reigniting supply blockages. Inflation continues to increase and is now widely baked into the economy. Historically, the single most significant cause of accelerating inflation is money supply growth. When you have more of something, its price goes down if demand stays the same. We've been pumping trillions of new money into economies since 2008, exacerbated by COVID support. Money now buys less, therefore the price of goods and services go up.

Are we heading into a recession?

The Bank of England has been attempting to curb inflation through four consecutive rises to the base interest rate, which now stands at 1% – the highest level in 13 years. However, it is now beyond being able to contain the cost-of-living crisis to a short, one-off shock, with the Bank’s governor Andrew Bailey admitting he feels “helpless” to stopping inflation. Last month, inflation hit a 40-year high of 9% and it’s expected to hit double figures by autumn.

While the economy grew in the first quarter of 2022, by 0.8%, it shrank by 0.1% in March as households began to feel the effects of the cost-of-living crisis. Analysts are warning the risk of a recession has risen, though most stop short of predicting one. The Bank now expects the economy to shrink in the final quarter of 2022 and predicts a 0.25% contraction in 2023.

How have these events impacted the financial markets?

Generally, not too well. Investors don’t like volatility and as a result market sentiment was fragile even before interest rates started rising, simply in anticipation of rises. Bonds have historically been seen as a safe haven during difficult times, but they too have suffered due to rising inflation and interest rates - if your future income isn't going to buy as much, you should pay less for it. In the equity market, technology stocks are especially suffering.

Having been the darlings of investment portfolios during the pandemic, now they are in decline. This is partly because of the return to normal pre-Covid spending habits - the days of ‘stay at home’ when tech and e-commerce were the saviours are over - but it's mainly because a lot of tech stocks' prices reflected over-optimistic expectations for future growth, which are now being severely revised.

Which parts of the market do well during periods of high inflation?

‘Old world’ cash-generative companies, such as in financial services, energy and industrials, tend to do better in high inflation and interest rate environments. This is partly why the FTSE 100 has held firm in contrast to the US markets, because it’s full of these kinds of businesses. Debt is a threat when interest rates are rising, so companies with robust balance sheets and strong brands are a good bet in an inflationary environment.

Is now a good time to buy into the market?

When markets are volatile, there will always be opportunities. But the truth is, no one knows when the best time is to buy into the market. Accurately predicting the bottom requires luck, not skill. You can investigate appropriate opportunities on a one-to-one basis with your investment manager. Generally speaking, however, "time in" the markets is more important than timing; patience makes profits. Engage with your investment adviser but stick to your long-term plan.

Do I need to alter my investment strategy in light of the market volatility?

The key to a successful investment portfolio is diversification and selectivity. The latter allows your investment manager to make decisions about the different assets you hold, within your particular risk mandate, to maintain balance in your portfolio despite changing economic conditions. Investment managers change the asset allocation within your risk budget swiftly if necessary. They will therefore be constantly evaluating the current market and your risk profile to make the best long-term decisions.

Do I need to change my financial plan?

Remember, your financial adviser worked with you to create a financial plan that will meet your goals in the long term. However, you might feel that you need more income to get you through the cost-of-living crisis more comfortably. If you are retired, your day-to-day expenditure could be higher than you thought it would be at this stage, when you first mapped out cash flow with your financial adviser. If that’s the case, your financial adviser will be able to utilise Ascot Lloyd’s cash flow modelling tools to revisit your circumstances.

There are ways to access income without having to ramp up pension withdrawals during a period of market decline. Equity release loans, for instance, unlock a tax-free lump sum of your home's equity while ensuring 100% of the property remains with you as the owner. This is just one example. Your financial adviser will be able to present the opportunities available to you. Always draw a sensible income and ensure you have the capacity for loss.

Is there light at the end of the tunnel?

There are reasons to be hopeful. Covid cases in China are falling and shipping costs appear to have peaked. Though inflation will continue to be a concern through 2022, many commentators hope it will start to ease in the first half of 2023. Though it can be difficult not to worry when you see your bills going up by 50%, it’s important to remember that the cost-of-living crisis will pass. Stock market falls are always to be expected, but despite intra-year declines, annual market returns are positive more often than not. This underlines the need to remain calm during a storm, sticking patiently to your long-term plan.

Ascot Lloyd’s Independent Financial Advisers develop a robust, long-term financial plan bespoke to your circumstances and needs. They will work with you to explore your options during the cost-of-living crisis and revisit what you need to achieve your financial goals.

Please contact your adviser in the usual way if you have any questions about your financial plan or circumstances. Alternatively, you can get in touch via the contact form below or the telephone number at the top of this page.

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