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Inflation, interest rates and lockdowns – what to look for in 2022

We look at the big-picture trends we expect to see in 2022 and what investors need to think about.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Matt Britzman
Equity Analyst

Published on 30 December 2021

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

If the last few years have taught us anything, it's to expect the unexpected. Understanding some of the larger financial forces at play can help you position yourself to weather storms, or even take advantage of them.

That's why we've looked at how inflation, interest rates and lockdowns can affect the economy, and what investors should think about.

This article isn't personal advice. If you're not sure whether an investment is right for you, seek advice. Unlike cash, investments and any income they produce will rise and fall in value, so you could get back less than you invest. Past performance isn't a guide to the future.

Inflation

Inflation is the overall rise in prices in the economy. There are different ways to measure it and we still don't have a unanimous consensus about what causes it.

What we do know, is that inflation is on the rise. The Consumer Prices Index (CPI), which is a measure of inflation, rose by 5.1% in the 12 months to November 2021. That's one of the largest increases of the last 20 years.

Over the last year central banks have pointed to inflation being ‘transitory'. The argument being supply constraints and pent-up demand were causing a perfect storm of short-term spikes in inflation. More recently, it looks like that consensus is changing. And inflation is expected to stay high into 2022.

When looking at how companies might fare in an inflationary world, there are some core principles we can look at.

Miners fit the bill of companies that can typically take inflation in their stride. And that's down to what they produce. Commodities, like steel and iron or even precious metals, get their price from market forces of supply and demand.

When general prices in the economy are on the rise, that often feeds into a rise in commodity prices, meaning they can sell their goods at a higher price. Miners can offset the cost of inflation, by earning more on the goods they sell. That makes them a potential hedge in a world with rising inflation.

Inflation means we're left with less spare cash. As the prices of essential items increase, like groceries and fuel, that leaves less for consumer discretionary businesses to fight over. Discretionary items are the non-essential, but desirable products. When we're flush with cash, we could be happier to splash out. But when the purse string tightens, they're the first to go.

Branding here plays an important role. Companies with strong brands might be able to pass some of their rising costs onto customers without hurting their volumes.

The big brands have loyalty power, and cheaper options might hang in there for longer. The most dangerous place if inflation is high is for middle of the road companies – average brands with average prices.

Interest rates

Interest rates are likely to be another big talking point for 2022, and they usually come in tandem with inflation. Central banks use interest rates as a tool to control the money supply. Higher rates typically mean savers get more for their cash, and it becomes more expensive to borrow money. That makes some of us save more and spend less. It can help keep a lid on inflation.

The Bank of England recently increased the base interest rate from 0.1% to 0.25%. It's the first time interest rates have risen in over three years, but we aren't at pre-pandemic levels yet. And with inflation currently above 5%, and expected to reach 6% in April, gradual interest rate rises could be on the cards for 2022.

Banks should be one of the winners if interest rates rise. The difference between what a bank can charge on its loans and the amount it's paying out on deposits is known as the Net Interest Margin (NIM). When rates rise, you'll typically see the cost of loans rise more than the rate you can get on a deposit with the bank. That's the bank's way of increasing their NIM and therefore revenue.

On the flip side, high growth businesses have been enjoying the low-rate environment for a while. Firstly, with the cost of borrowing so low, loans have been easy to come by and cheap to finance. That's great news for newer businesses with lots of growth potential, but limited earnings.

Secondly, high growth businesses are usually valued based on what they might grow in to. This is calculated by looking at what the value of their expected future cash flows is today, using a discounted cash flow formula.

The current ‘risk free rate' is factored in. That's often a by-product of the current interest rate.

When rates rise, the discount rate rises, and the effect is a reduced current value of future cash flows. This makes a business whose value is largely based on future income worth less than it is today.

Lockdowns

Stock markets are likely to remain sensitive to the spread of new Covid variants for some time yet. And it's something that's rightly on investors' minds.

Even the possibility of a lockdown is enough for markets to react. And some sectors are affected more than others.

The Airline industry was heavily impacted by lockdowns in 2020. And any chance of further restrictions won't be welcomed news.

The large costs that come with operating an airline means if planes are grounded, bills still need to be paid. Groups can release staff and negotiate rental payments, but we've seen before that's not enough to stop the losses from mounting up.

Airlines also pay in advance for oil contracts to guarantee a certain price. When fleets are grounded, those contracts become useless as airlines need less fuel. But those contracts don't just disappear. If airlines aren't taking up the contracts, the charges can stack up.

E-commerce saw a boost during previous lockdowns, and online shopping rose to record highs. Over the last few years, we've seen an increase in online spending as we were forced to adapt to new ways of living. It's a trend that was in place already but has been accelerated by the pandemic.

Another round of lockdowns, or even if fears of going to public places grow, could add fuel to the fire for online platforms.

Businesses that either operate solely online, or have made good headway with their online platforms, could hold up better than bricks and mortar businesses should things get worse.

Things to think about

Investing is a long game, not a short one.

There's no hard and fast rule about how long investments should be held for, but we think at least five years is what you should have in mind. It's key to think about the long-term prospects and not make any rash decisions based on short-term changes to the environment.

It's important to review your portfolio now and again too. Have a think about whether it still suits your risk tolerance and whether you're still diversified enough. You can see how and where your money is invested by selecting the 'Portfolio analysis' tab once you're logged in to your HL account.

See our step-by-step guide to reviewing an investment portfolio

Diversification is essential to make sure you can weather different market ups and downs. If we could control how investments performed, the world would be a very different place. We can't. But we can spread our money, to be ready for their unpredictability.

By investing in different types of companies, different types of investments – like shares, bonds, and property – different parts of the world, or different investment styles your portfolio should be well equipped.

And then when your investments do go up and down, provided you've spread them smartly, you won't have to play guessing games or make rash decisions.

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