Investments team
August 2022

We have seen big increases in the prices of commodities such as crude oil, natural gas and coal over the past year or so. The most obvious effect of this is the impact felt on your wallet at the petrol pumps and through your household energy bills. But one side effect you might not know about is how energy price increases play a part in your investments.

Let’s start with one of the big things that happens when price rises like this take place. The price of other products and goods also goes up, causing inflation to increase, which then puts pressure on the Bank of England (BoE), and central banks in other countries or regions, to raise interest rates. The stock market tends not to like high inflation and can often have a wobble when it gets too steep, or spikes suddenly. Interest rate rises can also cause a dip in performance.

Why does this happen?

Your pension investment pot will usually be made up of a mixture of shares and bonds. Sometimes you might also be invested in property or other kinds of assets. This is known as diversifying your investment.

When inflation is high, bonds tend to not do well, because they offer a fixed level of interest over a fixed time period. The fixed rate of some bonds becomes less attractive when inflation rises as the value of bonds falls. And, because when inflation rises, interest rates often do too, it drives bond yields (the return you get on a bond) up, and prices down further.

Shares are also affected by inflation as it means the cost of materials, labour and other costs for companies you hold shares in all go up. It can also lower expectations on how much companies might grow and affect stock market volatility.

Higher interest rates also means the cost of borrowing money goes up, so any credit repayments they have, like bank loans, hire purchase agreements or overdrafts, will increase. That means companies might not have as much money available to spend on other things or could make a lower profit, which can impact their share price.

The impact on spending

If you have a bit less in your pocket, you will probably find that essentials like food and energy cost more and take up more of your household budget. This might mean you spend less than you normally would on ‘non-essentials’, which can drive down demand for certain industries and companies. Again, share prices of affected companies might be reduced as a result.

For companies who use a lot of energy in their everyday activities, big price rises like the ones experienced recently, plus reduced demand from customers can mean they decide to stop operations temporarily. In some parts of Europe at the end of 2021, for example, fertilizer production was halted while gas prices were so high, and China and India were both forced to reduce the amount of steel, aluminium, and cement produced. These kinds of actions can worry markets and send share prices downwards.

What about the long-term outlook?

It’s important to note that the stock market has had its fair share of ups and downs over the years and has always recovered, so there’s no reason to suggest the influence of recent inflation will be any different.

Of course, some shares will be more or less affected than others, which is one of the benefits of diversifying your pension investment. It can help spread your risk and reduce the effect of events like this on your investments.

A pension is a long-term investment. The retirement benefit(s) you receive from your pension will depend on a number of factors, including the value of your plan when you decide to take your benefit(s) which isn’t guaranteed and can go down as well as up. The value of your plan could fall below the amount(s) paid in.