Sunday Times Article on Inflation, 22 May 2022

Author: Jonathan Sheahan, Managing Director of Compass Private Wealth

Published: Sunday Times Business Section, 22 May 2022

Prices are rising. Fast. We’re reminded of this regularly with the monthly Consumer Price Index (CPI) data that gets release by the Central Statistics Office (CSO). As of April 2022, the CPI Index in Ireland was up 7%% on a 12-month basis, and all indications are that this rate could get close to double-digits sooner rather than later. While the current inflation rate at high single digits is startling and uncomfortable, this is partly down to the fact that as a society we have got used to this utopia of a low-interest rate environment.

In the 14 years from March 2008 to March 2022, the total rate of increase in CPI as per the CSO was 1.9%; and this is not 1.9% per annum; this is a total of 1.9% over 14 years. However, between March 1973 and March 1975, prices rose by a total of 40.5%. For the decade from March 1970 to March 1980, there was total inflation of 248.7%. So, while the current inflation rate in Ireland is concerning, we have to put it in context. In the most immediate post, as noted above we had negligible prices rises in the last 10 – 15 years. However, when we go further back, as a result of the Oil Crisis of 1973 and a litany of other factors, there is clear evidence of how devastating inflation can actually be and anybody who lived through the 1970s and early 1980s in Ireland will attest to that.

Why are Prices rising?

There are 4 main reasons for this current high global rate of inflation, which together have been the ‘perfect storm’ for global inflation:

·        The first reason is the vast and abundant supply of money for over a decade to the global financial system. Central Banks have been providing cheap and plentiful liquidity through Quantitative Easing (QE) since the recovery from the global financial crisis from 2008 / 09 onwards

·        The second reason is also to do with the supply of money. Just when Central Banks were ‘tightening the belt’ in early 2020, emergency, unprecedented and radical measures were taken by Governments and Central Banks to flood economies with additional cash to keep businesses alive after the Covid-19 downturn.

·        The third factor is the general supply chain issues as a result of Covid-19 restrictions and the Russian invasion of Ukraine.

·        Finally, from a demand point of view, we are now seeing consumers getting back to the same levels of demand for goods & services as were in place before Covid-19. The inability of supply to keep up with this refreshed and increased demand has the fundamental economic outcome for prices increasing.

Inflation for you:

We have to understand that every household is unique and people in society ultimately consume goods and services on different things at different stages of life. Furthermore, every household has a different profile of assets & liabilities, so some will be more or less affected than others.

I would suggest that inflation is looked at from a Cashflow and Capital point of view.

Cashflow:

From a personal financial planning perspective, it is imperative that you calculate your personalised inflation rate and how a prolonged inflation environment will impact you. By way of example, when we break down this most recent 7% inflation rate for April, there are 2 main sectors were disproportionally higher: Transport costs were up 18.7% and ‘Housing, Water, Electricity & Gas’ was up 17.4%.

·        So, for a household that has a daily commute by car and has a large house with a poor energy rating, their inflation rate would most likely be significantly higher than the generic published CSO rate.

·        At the other end of the spectrum, somebody renting a relatively new apartment with a high energy rating in a City Centre who can walk to work daily may not be experiencing any price rises in their pocket, especially given the fact that their rent is capped at 2% p.a. also.

Every family should carry out a detailed household budget on an annual basis so that they can understand the impact that Inflation will have on their cashflows. All outgoings should be broken down on a monthly basis and also categorised as to whether they are Essential or Discretionary. Furthermore, costs should be broken down into Categories. Having a budget like this will then enable families to clearly see how higher prices will impact them on a monthly and annual basis.

Capital:

When considering your overall Assets across all structures as a Portfolio it is important that your overall Asset Base is diversified in such a way that it can try to keep up with inflation on the one hand, yet not lose money on other hand.

·        Too high a proportion of your assets in cash or long-dated Bonds will certainly mean that the real value of your capital will be eroded on an annualised basis

·        Conversely, we have to be mindful that any asset class other than Cash, such as Equities & Property, has capital risk associated with it and one should be mindful of not ‘chasing inflation’ by taking risks that they don’t have the capacity to withstand any market sell-offs.

So, one should only invest capital if there is a long-term time horizon so that, over many years, the probability of the investment portfolio out-performing inflation will increase. ln terms of mortgages, selecting the right mortgage term and rate is now more important than ever as we move into a potentially higher-interest rate environment.

So, in summary, we are no longer in a benign inflationary environment. We have to come to terms with the fact that the next few years will be volatile in terms of the price of goods and services and also the value of our capital investments. Personal financial planning is more important now than ever.

Jonathan Sheahan is Managing Director of Compass Private Wealth with offices in Dublin and Cork.

Disclaimer: The above is generic in nature and does not constitute financial advice.