Stagflation: are your savings at risk?

Rising energy prices have reignited fears of ‘stagflation’ – an environment of high inflation, increasing unemployment and slowing economic growth.

Spiralling energy costs have been making life hard for millions of families, with official figures revealing inflation running at 5.5 per cent. It’s now feared these hikes could put businesses under such severe pressure that we see a return to the gloomy stagflation of the 1970s.

But what would this mean for savers and investors – and what do the financial experts suggest will help counter its effects within portfolios?

Real threat

Victoria Scholar, head of investment at interactive investor (ii), said there were echoes of the oil-price shock in the 1970s, when rising commodities led to spiralling inflation and falling economic growth.

“The threat of stagflation is real and growing, with fears about a slowing global economy brought about by a cocktail of pressures, from Russia’s invasion of Ukraine, a backdrop of inflation, and the prospect of yet another lockdown in China following its recent surge in Covid-19 cases,” she said.

With the US, the UK and Australia banning Russian oil imports, Scholar pointed out that the war has led to a major imbalance in the energy markets, with demand sharply outstripping supply.

“Inflation looks set to march higher, exacerbating the cost of living crisis and reducing the overall affordability of goods and services in the economy,” she added.

Monetary policy

The combination of factors could have a damaging effect on the wider economy, according to Sarah Coles, personal finance analyst at Hargreaves Lansdown.

“The risk is that rising prices feed into the existing challenges for businesses, which could be forced to pull back on production,” she said. “This could send economic growth into a downturn.”

It could also mean more people out of work.

“This would make monetary policy particularly difficult, as the higher rates the Bank of England would normally employ to control inflation would risk exacerbating unemployment,” she added.

Impact on savers

So, what does this mean? An economy facing stagflation doesn’t bode well for savers, as the value of cash in the bank quickly erodes as inflation rises.

Currently, the best easy-access savings accounts only pay 1 per cent AER, according to data compiled by Moneyfacts.co.uk. You’d need a three-year fixed-rate bond to get above 2 per cent.

However, Sarah Coles insisted such modest rates shouldn’t deter people from holding savings accounts, as they still have a useful role to play.

“During tough economic times, it’s particularly important to have an emergency savings safety net of three to six months’ worth of essential spending in an easy-access account,” she said.

Selective positioning

The unstable economic backdrop requires investors to be selective in terms of their stock and investment picks, according to Victoria Scholar at ii.

“Investors could look towards commodity and commodity-linked assets as a way to make the most of this market,” she said. “Oil and mining companies have been outperforming.”

Scholar also believes the financial sector could perform better as the global monetary policy regime shifts to tightening, with rising interest rates improving their earnings.

“Consumer staples stocks, which sell essential goods, could fare better in a stagflation scenario, since these goods won’t be cut from the shopping list when times get tough,” she added.

Responding to stagflation

According to Darius McDermott, managing director of FundCalibre, investments with inflation-linking capability or pricing power could be beneficial.

“There are sectors like infrastructure, specialist property REITS (real estate investment trusts),” he said. “Anything with some form of inflation-linking to it will be helpful.”

He also emphasised funds exposed to the commodities story.

“Commodities tend to do well in inflationary times because their prices go up,” he said. “You have BlackRock World Mining Trust or Ninety One Global Gold.”

Effect on investments

While inflation continues to rise, it’s too early to know for sure if we’re headed for stagflation, so it may be risky to make too many changes, according to Danni Hewson, financial analyst at AJ Bell.

“Long-term investors really need to look through the current crisis,” she said. “Companies they liked yesterday should also perform in the future, and making moves now could be a costly mistake.”

However, she also highlighted how inflation-linked bonds and the energy sector are often viewed as potential stagflation hedges.

“Diversification is often touted as the best form of hedging, but with inflation hitting different parts of the world at different speeds, investors should pay attention to currency changes and consider current valuations,” she added.

UK opportunities

Jason Hollands, managing director at Bestinvest, suggested the UK market’s composition meant it should be pretty resilient in an inflationary environment.

“Share valuations are less stretched, which gives a degree of comfort alongside its position as the premier market for dividends,” he said.

Bestinvest’s key UK equity fund picks include Artemis UK Select, Premier Miton UK Growth, and Fidelity Special Situations – and for dividend seekers, Threadneedle UK Equity Income and the Temple Bar Investment Trust.