Wider economic factors

Have you noticed how your weekly shop, your rent, or even the cost of filling up your car seems to creep up over time? That’s inflation and it’s just one of the big economic forces that can affect your money. In this video, we’ll explore the main factors that influence your investments, from inflation and interest rates to global events. By understanding these, you’ll be better prepared to make decisions that protect and grow your money over the long term.

Let’s start with inflation and interest rates. If you want to increase your wealth, then your investments will need above-inflation returns. Inflation is when prices rise over time, which means your money doesn’t stretch as far. The same £10 note will buy you less next year than it does today.That’s why it’s important to understand the difference between two types of returns, the one you see on paper and the one you feel in real life. The return you see on paper is called the nominal return. But when you adjust for inflation, that’s called the real return.

Here’s an example. Imagine your savings grow by 2% in a year, but prices in the shops rise by 3%. On paper you’ve earned 2%, but in reality your outgoings will be around 1% more. So even though the number went up, what you can do with it actually went down. Some types of investments like property, commodities or inflation-linked bonds may hold their value or even increase when inflation is high. But if your money isn’t earning any interest at all and prices are rising, the value of that money goes down over time.

So if inflation eats away at the value of your money, what helps to keep it in check? That’s where a central bank comes in. In the UK, that’s the Bank of England. The base rate, set by the Bank of England, is the single most important interest rate in the UK. It helps determine all other rates of interest charged or paid across the economy. The bank’s main goal is to keep inflation around 2%. When the base rate goes up, banks usually increase the interest they charge on loans and the interest they pay on savings. This makes borrowing more expensive and saving more rewarding. As a result, people tend to borrow less and save more. When spending falls, demand in the economy slows down. Businesses may cut back, which can mean fewer jobs or slower wage growth. Lower wages and fewer jobs put pressure on prices, which helps to bring inflation down.

Changes in the base rate ripple through the stock market. Lower rates often encourage growth, boost company profits and push up share prices. But not every industry benefits in the same way. Large companies may gain more from cheaper borrowing, while banks and financial institutions can sometimes see their profits squeezed when rates fall. The base rate also affects investments. Take bonds, for example. Their prices usually move in the opposite direction to interest rates. When the base rate rises, bond prices tend to fall. And finally, higher rates also make mortgages more expensive, which can put downward pressure on house prices. That’s why interest rates are important to think about if you’re buying a home or investing in property.

Then, there are world events. World events can also have a big impact on the value of your investments. Things like conflicts, pandemics or political uncertainty can cause prices to swing sharply, often without warning. It’s normal to feel worried when values drop suddenly, but this is part of how markets work. This is where diversification really helps. By spreading your money across different types of investments, you reduce the risk of everything falling at the same time. For example, during the 2020 pandemic, airline shares dropped sharply, while video platforms and pharmaceutical companies rose in value.

The lesson here is simple. No one can predict the future, but you can prepare for it. A long-term strategy, combined with diversification, gives you the best chance of riding out the ups and downs and keeping your financial goals on track.