What the UK’s inflation drop could mean for investors & borrowers ??

The Office for National Statistics announced this week that inflation in the United Kingdom has fallen to 1.7%, marking the first time in over three years that inflation has dropped below the Bank of England’s (BoE) 2% target.

What could this mean for you?

Lower Interest Rates

With inflation falling, the pressure eases on the Bank of England to maintain high interest rates. This opens the door for further rate cuts, after the BoE began its rate cutting cycle in August, reducing the base rate to 5%.

Lower interest rates benefit the stock market in several ways:

• Lower borrowing costs: Businesses can access cheaper loans to invest in growth, expand operations, or refinance debt.

• Stronger consumer demand: With lower interest rates, consumers have more capacity to borrow and therefore spend, boosting sales for companies across sectors.

• Higher Valuations: Lower discount rates increase the present value of future cash flows, leading to higher stock valuations.

• Attractive Dividend Yields: With lower interest rates, dividend paying stocks become more attractive in comparison, encouraging investment into the stock market.

• Less Incentive to Hold Cash: Lower interest rates could tempt those who have been taking advantage of the high interest rates available on cash holdings to invest in the stock market instead.

It was already widely assumed that November would see a further 0.25% rate cut. The hope amongst experts now shifts to the possibility of an additional cut in December, which could provide fresh momentum to the markets.

Bond Market Gains

Lower interest rates will lead to newly issued bonds offering lower rates. This benefits investors holding existing bonds, as their higher coupons become more attractive in comparison.

At the start of the year, bonds were widely expected to perform well after a challenging period of high interest rates over the past two years. However, the prolonged stance of central banks in maintaining higher rates delayed the anticipated recovery.

Now, with signs that further rate cuts are on the horizon, bond prices could finally see their long awaited rebound. Investors are positioned to benefit from both price appreciation and favorable yields on existing holdings. If further rate cuts materialise, especially into December, the bond market could gain additional momentum.

Preserved Purchasing Power

When the cost of goods and services rises, it erodes the real value of savings, investments, and income. Retirees, who often rely on pensions or income from investments, are particularly vulnerable to this erosion. They typically have less ability to increase their income, and less ability to increase the risk of their investments to outpace inflation.

Over time, these higher costs can force retirees to either lower their standard of living or dip into their savings earlier than planned, jeopardising their long-term financial security. Lower inflation helps mitigate this risk, making it easier for retirees to manage their daily living costs without drawing down on savings prematurely

Moreover, a low-inflation environment offers retirees more room to keep their investments in safer, lower-risk instruments—like government bonds or dividend-paying stocks—without needing to chase higher returns by investing in volatile markets. This aligns well with the typical goal of retirees: capital preservation and predictable income.

Potential Downsides

It is worth also touching on some possible downsides of a drop in inflation.

• Lower Savings Rates: If the BoE cuts rates further, returns on cash deposits will decline, reducing the appeal of holding cash.
• Weaker Pound: A drop in inflation often leads to a weaker GBP, reducing the purchasing power of UK residents when travelling or spending abroad. This is particularly relevant for GSB clients, many of whom are British expats.

Summary

The larger than anticipated drop in UK inflation provides several opportunities for investors, with prospects for further interest rate cuts boosting both stocks and bonds.

However, those relying on cash savings may need to reconsider their strategies, and a weaker pound could pose challenges for expat investors with international expenses.

Get in touch

Contact GSB today if you would like to discuss any of these matters with our in-house team.

*All figures are indicative only and not intended to act as financial or investment advice. Nothing in this communication constitutes investment, legal, accounting, tax advice, or a representation that any investment strategy is suitable or appropriate to your circumstances.