The past two weeks have shifted inflation expectations from a gradual float down towards the Bank of England’s 2% goal, to another steep climb, and back again to somewhere in the middle as the market attempts to predict what will happen next in Iran.
This is a near impossible task. The recent spikes in anticipated levels of inflation have been driven by oil prices, which rocketed following the start of the US and Israeli conflict with Iran. But after Trump announced on 9 March that the conflict with Iran would be ending ‘very soon’, oil prices were quelled, as was some of the concern about inflationary pressures. Unfortunately, there’s no way to know if this stance will hold, and if the conflict is really nearing its end.
But the uncertainty leaves investors in a difficult position – should investments stay the course, or do they need to adapt with the environment? To understand the right move for your money, it’s first important to understand what a rise in inflation means.
What would a rise in inflation mean?
A rise in inflation doesn’t just mean that the cost of products will rise. Even if inflation lowered to 2%, which is the Bank of England’s goal, products will still cost on average 2% more each year. So, a grocery run that cost you £100 at the start of the year would cost you £102 by the end.
Inflation is a natural function of the economy, but when it increases to higher levels, it means that consumers can have a harder time keeping up. The most recent inflation reading in the UK, based on the consumer price index, was 3%.
If inflation keeps climbing, the increase in that rate could meant that consumers are paying closer to £104 for that grocery run that cost them £100 at the start of the year. This might seem like a relatively small increase, but the Office for National Statistics estimates that the average expenditure for a UK household is £663 a week. If that increased by 4% in a year, it would mean the cost of spending on the same items would be more than £689.
We can’t accurately predict future inflation, because there’s so many factors that come into play. The Bank of England will also often attempt to counteract inflation through a shift in interest rates. While interest rates have been going down since 2024, this could very well change this year. Expectations now call for interest rates to stall this in 2025, while before the Iran conflict, the market was pricing in a cut at the Bank’s meeting on 19 March.
How inflation could affect your spending
A rise in costs doesn’t typically happen in a uniform way across all goods and services. In this case, oil will be the main catalyst for rises as supply from the Middle East is slowed. Fuelling our cars is the first thing many of us will think of when it comes to higher prices, but this could translate to other areas as well, such as travel. Oil is also used in the production of plastic, which means that goods like clothing or food containers could come with a higher price tag.
Energy prices could be on the rise, although Ofgem had already established an energy price cap of £1,641 for a typical household per year, that is in place from April through June. So, any rises in energy bills would be seen after this.
Some of these costs are hard to prepare for besides looking for savings elsewhere and knowing the extra cost is coming. But others might be avoidable. Flights, which are highly dependent on fuel prices, could increase in price throughout the year, so making bookings now may mean avoiding a higher price months down the line.
If the price of energy rises after June, there will be some relief from no longer needing heating in summer. This is by far the single largest cost on energy bills. But if you’re looking to pinch pennies, you could also opt for air drying over the tumble dryer, which Octopus Energy estimates saves £133 a year.
How inflation could affect your investments
Investments become increasingly important during periods of high inflation because it becomes a way to protect the value of your money. The higher inflation is, the more it eats into the purchasing power of the money you have at your disposal.
This means you’ll want to try and keep your returns above the inflation rate to just maintain the value of your savings. Anything on top of that would be growth. This is where cash earning interest can fall short, because if inflation outpaces that cash interest rate, you end up with effectively less ability to spend.
Bonds
Bonds can often struggle in this environment, whether you hold them outright or in a fund. If they are held outright, you’ll want to monitor how their returns match up against inflation. Bonds that were issued in a low interest rate environment might have low coupon payments, meaning that you aren’t making a lot by lending that money. If inflation surpasses the return you are making on your bond, your purchasing power is being eroded.
If you hold a bond fund, the scenario is slightly different because the fund will often buy and sell bonds instead of hold them to duration to create returns. However, if interest rates increase, this likely means that new bonds will be issued with a higher coupon, making the current bonds less appealing.
The past five years has been difficult for the government bond market, with the IA Global Government bond sector falling by an average 5.6%, and the UK gilt sector falling by 19.8%. Even the sector for global corporate bonds is up just 7.8% over five years. Over that same period, prices have increased by 25%, according to the Bank of England.
For those that aren’t prepared to take on the risk of equities but want to ensure that their savings stay above the rate of inflation, there are also inflation-linked gilts. These investments adjust their payments and value based off the current rate of inflation, plus a little on top. This guarantees that the bond will keep its value, assuming it doesn’t default. Since these are UK government bonds, that risk is relatively low, but so are the likely returns.
The stock market
Stock markets have taken a tumble since the conflict in Iran began, with the MSCI World now down 0.1% on the year. But this isn’t the case for all regions. The UK’s FTSE 100 has returned 3.6% this year, even after the recent pullback, demonstrating the benefits of portfolio diversification.
Interest rate changes affect the stock market because higher rates reduce the borrowing power of companies and higher rates increase the appeal of lower risk alternatives like cash.
Analysts are aware of these trends, so even though the affects of a higher cost of debt may not appear in company financial reports until a year from now, it’s likely already begun to be priced into the market. While it may make investments look a bit depressed now, it can be helpful in the long term because it tempers the possibility of a market drop down the line, when the effects come into play.
Ultimately, inflation and interest rates are just one of the many factors that affect the financial markets. After Nvidia’s latest results on 25 February, which caused a market grumble event though the numbers met company expectations, the S&P 500 dropped by 0.97% in the following two days. In comparison, in the two days following the start of the Iran conflict, the S&P dropped by just 0.18%.
This isn’t to say that the impact over time will be smaller, but a broad range of factors can affect the stock market, and in some cases, individual companies. Sometimes, these changes can make what seems like a significant market event in the moment quickly fade into relative obscurity.
Hannah Williford: Content Writer
Hannah joined AJ Bell in 2025 as an investment writer. She was previously a journalist at Portfolio Adviser Magazine, reporting on multi-asset, fixed income and equity funds, as well as macroeconomic impacts and regulatory changes...
