Depreciating Pound or Rising Inflation: Which is the Bigger Issue for the UK?

For the UK’s HNW and UHNW investors, the UK faces two major issues: a pound falling in value and rising inflation. The latter is pushing the country even further into a recession that, just recently, has been predicted to last well into 2023, if not 2024.?

In September 2022, the GB pound fell to its lowest level against the dollar, to just $1.05. Admittedly that was in the wake of the Truss/Kwarteng ￡45bn tax-cutting mini-budget. A new Chancellor and a new Prime Minister have reversed the economic panic, and the pound's value has rallied to $1.129 since then.?

But with the Bank of England (BoE) announcing that inflation had gone back to double figures in September, to 10.1%, it is not surprising that the financial markets are still a bit jittery. The BoE has just announced its largest interest rate hike by 0.75%, to 3%, which it hopes will slow the inflation rate in the UK. Interestingly, this increase follows a hike in interest rates by the European Central Bank and the US Federal Reserve.?

So, for the UK that wants to attract investors and encourage growth, which is the bigger issue; the depreciating pound or rising inflation?

The depreciating pound

Contrary to what some may think, the fall in the value of the pound is mainly due to the UK’s economic issues rather than a strong US dollar. Indeed, the US has also been dealing with an inflation problem. However, the fact the pound’s value is falling does reflect that the UK has a higher inflation rate than the US.?

This, in turn, causes the international financial markets to believe the UK’s economic policy is in a freefall or, at least, going the wrong way. The last time the UK experienced a falling pound was just after Brexit, but, at that time, there wasn’t a rising inflation issue, and the pound recovered quickly.

Six months ago, although inflation was steadily rising, the pound's value was holding steady, and the international financial markets still had confidence in the UK. Confidence that the UK could pay its debts was stable, and investors were still encouraged to invest in the UK, particularly if they had a long-term view.

However, a decision by a new government to announce far-reaching tax cuts based on borrowing without a comprehensive way of explaining how it would be repaid caused the financial markets to panic. Not only did this put the BoE into the unenviable position of stabilising the markets by buying gilts and bonds, it also drove inflation back up when it started to fall.?

Rising inflation

Following the tax-cutting mini-budget in September, inflation rose again in the UK and broke into double figures at 10.1%. Whilst the level of inflation hadn’t started to fall in the previous three months, it had undoubtedly levelled out. There were even predictions that it could begin to fall before the end of 2022 and potentially hold off a recession.?

This was despite the ongoing Ukraine-Russia conflict that is directly impacting energy prices, food supply and therefore rising food costs. Talk of enforced blackouts had grown quiet, and the financial markets still felt an element of confidence. However, this all changed in September.

The latest inflation figure has been attributed to consumer goods being at a higher price, underpinned by continued strong demand from consumers and compounded by supply chain issues. Indeed, the UK’s housing market has not seen any real impact from rising inflation or a depreciating pound.?

However, the higher inflation goes, the harder it is for people to keep up with the rising costs of living. This is because their wages, in real terms, aren’t keeping up with inflation. Many businesses have had to cut back to meet their increasing energy costs. Production levels are down on the previous quarter in 2022, resulting in lower sales income and shorter growth. This is reflected in lower wage increases and, therefore, less money in the consumer's pocket.?

In addition, whilst a little inflation is not a bad thing (the BoE likes to keep inflation around the 1.8% to 2% mark), high inflation also negatively impacts savings and investments.?

Which is the bigger issue?

Ultimately neither is the bigger issue as both have an impact on each other. A pound that is falling in value usually causes a rise in inflation. This is because, generally, it is indicative of a weak economy that is weak, or at least struggling, which, in turn, leads to a lack of confidence in the international financial markets.

Imports also become more expensive, which impacts materials, operations and production costs. There is increased pressure to raise the interest rate, which results in a lack of investor confidence in the UK.

Rising inflation results in reduced purchasing power for consumers and policymakers in government. Essentially the cost of consumer goods, energy, materials and commodities goes up, but the average person’s wage packet doesn’t keep pace with inflation.?

To slow the rise in inflation, pressure is on the BoE to raise the basic interest rate, which, in turn, pushes up the cost of borrowing. So, people with mortgages and loans will pay more per month. For savers and investors, whilst a low level of inflation is a good thing, when it gets too high, as it is now, there is a possibility that your savings could lose value in real terms, and investors may not see as great a return on their investment. This is because investment returns must keep up with the inflation rate to generate a higher purchasing power. If inflation is too high, investments are unlikely to be able to keep up, and long term, an investor’s purchasing power diminishes.

International Wealth Solution Ltd (IWSL) understands the pressure a low-value pound and high inflation can have on an investor’s portfolio. Therefore, through our tailored high-net-worth wealth solutions for the HNW and UHNW, we can adjust and adapt investments to generate the best return possible.?

For the best advice on investments, family and succession planning, IWSL is here to help you with professional, experienced advice and comprehensive solutions. Contact us to see how we can help you.