Cash is not king: what falling inflation will mean for investors in 2023

They say cash is king, but that's not the case for investors. We examine whether inflation has peaked and what falling inflation means for investors in 2023.

There is finally light at the end of the tunnel for British consumers. Figures released this morning show inflation reduced from 11.1% to 10.7% in November, but sky-high food prices and energy costs mean that many Britons still have a tough winter ahead.

Many analysts were expecting a slight fall in inflation to 10.9%, but the Office for National Statistics (ONS) figures, published today, show that CPI inflation actually fell back more than expected, by 0.4%.

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Victoria Scholar, head of investment at interactive investor, explains that most of the fall was due to prices at the pump. “Fuel inflation fell from 22.2% in October to 17.2% in November. Some of the easing was also because of a technicality relating to a change last year in how the figure is calculated. Offsetting this to some extent, were higher prices for alcohol in restaurants, cafes and pubs.”  

Food inflation is also still rising, creeping up from 16.4% to a budget-busting 16.5% in November.

But despite falling inflation, pressures on the economy are still severe. Scholar explains that wages are lagging significantly behind inflation, “resulting in a drop in the affordability of goods and services in our economy. This has resulted in widespread strikes across many industries as the summer turns into the winter of discontent among workers.”

Has inflation peaked?

Most experts expect inflation to fall back significantly in 2023, but the jury is out on the details.

Scholar says that: “November’s reading is the first indication that inflationary pressures in the UK could be starting to ease after a year and a half. Whether we are passed the peak is yet to be seen with inflation still stubbornly high, stuck in double digits, and sharply above the Bank of England’s 2% target. The central bank is likely to raise interest rates again tomorrow in an attempt to cool economic activity and temper inflation.”

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The National Institute of Economic and Social Research (NIESR) expects high inflation to remain sticky, warning that: “inflation will remain well above 3% for the whole of 2023 and our current forecast is that it will not return to target [2%] until mid-2025”. The NIESR adds that an escalation in the war in Ukraine could further add to inflationary pressures, saying that “direct involvement of NATO – for example, Russian conflict directly with Poland – would rapidly deteriorate the picture for inflation”.

The Confederation of British Industry (CBI), the employers’ organisation, also expects high inflation to persist into 2023. “We expect consumer price inflation to have peaked in October and to fall gradually over the coming year,” it said, with inflation “[remaining] significantly above the Bank of England target over 2023, ending the year at 3.9%”.

Across the pond, the good news is that US inflation may have also have peaked. November figures released earlier this week reveal that US inflation for November fell to 7.1%, versus a Dow Jones estimate of 7.3%, falling from 7.7% in October. The S&P 500 rose 0.73% Tuesday in response to the news.

The erosion of cash savings

For UK savers, the picture is still grim as interest rates lag significantly behind inflation, and some rates have actually fallen as banks price in potentially lower-than-expected base rate rises.

Rachel Springall, finance expert at Moneyfacts.co.uk, encourages savers to shop around for the best savings deals but warned that no standard saving accounts can beat inflation. “Savers looking to grab a top rate will need to act quickly as some of the best returns on short-term fixed rate bonds have fallen in recent weeks. Table-topping brands have cut the rates on offer to adjust their market positions, leading to further cuts from other brands.”

But despite often pitiful saving rates, new research from Janus Henderson Investment Trustsreveals that many parents are still super-cautious when investing for their children, with 48% of regular savers opting for cash savings.

Dan Howe, head of investment trusts at Janus Henderson Investors, said: “Cash is essential for immediate needs, but it’s an expensive trap in the long term.” He warns that although rising rates may be tempting for parents, “History shows that [cash} only loses purchasing power over time, and returns fall behind stocks and shares over the long term too. Actually, the extended time horizon parents have when saving for their children is well suited to assets like investment trusts.”

Search for growth

Regular investors have a few more options when it comes to trying to outperform inflation. While it will be hard to beat 10.7% inflation in the short term, stock market returns tend to outperform inflation over time, especially once dividend income is taken into account. In general, the longer the time period, the more likely stock market investments will outperform cash and underlying inflation.

And regular pension investors can also make the most of generous tax rules, giving their contribution an immediate boost, with 20% or 40% tax relief added to their investments.  

When it comes to picking investments, Lee Wild, head of equity strategy at interactive investor, believes that US-based tech stocks could be due a rebound if interest rates begin to fall. Wild says: “Tech has had a torrid time in 2022 but has reacted positively to any hint that the US rate hike cycle is slowing. If rates peak soon or even begin to ease later in the year, growth stocks are back in play.”

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Sam Benstead, interactive investor’s deputy collectives editor, suggests that bonds could have a place in a balanced investment portfolio in 2023, especially with reduced prices and increased yields in recent months. He says: “Higher yields are tempting investors back into corporate bond funds, with prospects of interest rate cuts towards the end of next year to stimulate the economy also providing hope of capital gains.

“With inflation forecast to fall next year, investors who are happy to look out a couple of years are able to bag a positive real income from lending money to established companies. Yields have risen over the past year, with the average yield to maturity on sterling corporate bonds now at around 5%.”