Editor's letter

Inflation: compound interest’s evil twin

We're about to see something we've not seen for a while, says Andrew Van Sickle: a nasty bout of inflation.

MoneyWeek will turn 21 in early November. It has been a busy couple of decades. We’ve been through the dotcom bubble, two commodities supercycles, the housing bubble, a once-in-a-century financial crisis, and a once-in-a-century pandemic. 

We have, in short, been round the block more than a London traffic warden. But one thing we have yet to experience: a nasty bout of inflation. I wonder if we now will. 

Not so transitory inflation

John explains in detail why we’re worried in this week's magazine, but the (rapidly rising) bottom line is that all the signs are there. Massive money-printing, which this time is going straight into the system rather than plugging balance-sheet holes in banks as in 2008-2009. Supply bottlenecks, skill shortages and rising raw-materials prices – a combination that points to a wage-price spiral. And, last but not least, central banks and a majority of economists insisting that inflation at multi-year highs is transitory. These would be the same central banks and majority of economists that failed to see the financial crisis coming. 

It may not be long now before we start to notice the price of items we buy regularly tick up. We all have our own everyday inflation gauges. Mine is the Peppermint Aero. I remember that a bar cost me 22p in 1988. Now it sells for 60p. The Bank of England’s inflation calculator, by far the most interesting thing on the website, suggests that this is right: £22 in 1988 was £60 in 2020. Prices have almost tripled. 

The annual average rate since 1988 has been 3.2%, which doesn’t sound too bad. But apply that for 33 years and look what happens. Nudge it up to 5%, and money depreciates much faster. At that rate, £100 shrinks to £36 in 20 years. Inflation is compound interest’s evil twin. 

So keep an eye on your favourite cereal, chocolate bar or wine brand. Watch out for “shrinkflation” too. Sometimes the price stays the same but the package gets smaller. I seem to recall that the 1988 Aero bar was a tad longer. I couldn’t swear to it, but I do know for sure that only a few years ago, Cadbury’s used to sell six Creme Eggs in a package; now there are five. 

Where does this all lead (beyond Creme Eggs in packs of four)? It’s becoming ever clearer that central banks have no intention of squeezing inflation out of the system. They have subtly raised the bar on what they say they need to see or anticipate from inflation before they stop printing money via quantitative easing or raise interest rates. We hear repeatedly that inflation should be temporary, and they will look through it. They suggest they will tolerate above-target inflation for longer than they have in the past. This spring the US Federal Reserve changed its official inflation target from 2% to an average of 2% “over time”. Two weeks ago the European Central Bank shifted its inflation target upwards too. It now aims to achieve inflation of 2% over the medium term, whereas before it tried to keep inflation below but close to 2%. 

Interest rates can’t rise

The direction of travel is clear. The aim is to inflate away the world’s huge debt load – much of it caused by central banks keeping interest rates too low for too long, of course. A big jump in interest rates would cripple the global system. 

Bond yields remain historically low, as investors apparently assume that the disinflationary environment of the past 40 years will endure indefinitely. And central banks have bought up a huge chunk of the bond market with printed money, which also keeps yields low. The upshot? We are in for years of yields staying below inflation, which is excellent news for gold. If rates do eventually rise in an environment of out-of-control inflation, it will benefit too. I will be topping up my gold today – just as soon as I finish my 60p Aero. 

Recommended

Isas vs private pensions – which is better for retirement?
Isas

Isas vs private pensions – which is better for retirement?

Isas are becoming a popular option for retirement, but private pensions still have certain advantages.
7 Dec 2022
UK house prices see their biggest fall since 2008
House prices

UK house prices see their biggest fall since 2008

Halifax’s latest house price index shows UK house prices fell by 2.3% in November
7 Dec 2022
Which house-price index is the best?
Property

Which house-price index is the best?

Britain is obsessed with house prices, and we have at least four house-price indices to choose from to measure the rate of increase in the value of ou…
7 Dec 2022
Key dates for 2023: here are the dates you need to know when it comes to your money in 2023
Personal finance

Key dates for 2023: here are the dates you need to know when it comes to your money in 2023

There is no shortage of important dates to be aware of next year – which are likely to affect your financial health. We run through the key dates in 2…
6 Dec 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Radiator vs electric heater – which is cheaper?
Personal finance

Radiator vs electric heater – which is cheaper?

We compare the costs, pros and cons of radiators and electric heaters and see which one will help keep your energy bill as low as possible.
28 Nov 2022
The pros and cons of smart meters – should you switch?
Personal finance

The pros and cons of smart meters – should you switch?

A smart meter can help you keep tabs on your energy usage, but is it better than a regular meter? We take a look at smart meters vs regular meters.
2 Dec 2022