On 4th August, The Bank of England announced a rise in base rate from 1.25% to 1.75%, the biggest increase in 27 years, and the fifth rise this year. In this article we explore the relationship between the base rate and the Consumer Prices Index (CPI), which is the key measure of performance for our Blackfinch Asset Management multi-asset portfolio ranges. We also look at how our performance may be impacted by the newly announced base rate.

Understanding the Consumer Prices Index.

The CPI is produced by the Office of National Statistics (ONS), by measuring the price of a “basket of goods” on a regular basis. By measuring the same goods each time, the index allows an easy way of comparing how the cost of living is changing over time. In reality, the “basket” actually contains approximately 180,000 price comparisons, covering around 730 types of goods and services. Prices are collected both from a wide range of physical locations around the UK, as well as from internet providers and over the phone.

The list of items considered in the basket of goods remains the same in any one year, to ensure the results are consistent. An annual review of the list takes place to ensure the index reflects the main purchases considered important by a modern society. In 2022, 19 items were added including frozen Yorkshire puddings, meat free sausages and anti-bacterial surface wipes. At the same time, items removed from the basket include coal, doughnuts and men’s suits.

To read more about what is included in the basket and how it has changed over the years, visit the ONS: Consumer price inflation basket of goods and services - Office for National Statistics

Because the CPI is used to reflect the cost of goods which the majority of the population relate to, it’s widely considered as one of the best indicators of inflation.

How does the CPI relate to base rate?

The base rate is the official interest rate set by the Bank of England Monetary Policy Committee and is used to calculate the cost of money loaned to banks and financial institutions. The base rate sets the cost of lending from those institutions to their clients, so any changes in the base rate are generally passed down to consumers on flexible lending products by a corresponding change in their interest rate.

Changes to the base rate affect how consumers are likely to use their money – whether they want to spend or save. Because of this, the government uses changes to the base rate as a way of controlling inflation.

If the base rate increases, the cost of borrowing goes up which makes it harder for people to afford debt such as mortgages and loans. At the same time, as interest rate rises are passed on to savings products, it becomes more favourable to save than to spend. As economic output falls, prices rise further and the CPI follows the trend of the base rate.

The flip side is when the base rate drops, lending to consumers becomes cheaper and savings products become less rewarding. This makes consumers more likely to spend on purchases such as houses and cars. Economic production goes up and costs come down, so the CPI eventually mirrors the fall.

Recently we have experienced a complex set of economic conditions, influenced by several factors. As we exited the pandemic there was a huge surge of spending, but markets struggled to keep up with the demand as supply chains were disrupted from political instability around Ukraine. This disruption also impacted energy and fuel prices, resulting in some companies passing on the increased costs to their customers. The outcome is that we are seeing an increased cost of living and a higher CPI. With the Bank of England announcing an increase to base rate, they are encouraging a slowdown in spending. The combined effect is news headlines talking of a recession.

How are Blackfinch Asset Management portfolios affected by UK inflation?

Blackfinch Asset Management use CPI as a benchmark for performance of our multi-asset portfolio range because it’s the most relatable metric to retail investor goals. It’s easy to understand, helping investors to engage with the performance of their investments and gain greater confidence that their desired outcome is being achieved; maintain the purchasing power of their money over time plus capital growth on top.

The first, and most important point is that our portfolios are diversified globally. This means change happening in the UK markets is only affecting a relatively small proportion of our investments at any point in time.

During periods of economic change, different asset classes (and geographies) will respond in either favourable or less favourable ways, and at different times across the cycle. So, the second consideration is our research team who have deep expertise in ensuring the portfolios are diversified across a wide range of asset classes. They are also acting swiftly and in an agile way to monitor changes and rebalance portfolios appropriately on a regular basis.

This also enables the team to be able to locate other economies and opportunities around the world where there is potential for growth. Examples of these include alternative asset pools which include infrastructure opportunities. Our investment into these offers our investors long-term cash flows and a balancing of risk by the use of inflation linkage in the contractual terms.

Examples of alternative asset pools:

  • Data centres
  • Telecommunications towers
  • Shipping ports
  • Toll roads
  • Wind farms
  • Solar farms
  • Hydro-electricity plants
  • Governmental building such as schools and hospitals.

Combining both of these approaches in a thorough and committed way helps to shield our investors from changes occurring across the UK economy in the wake of the Bank of England announcement.

If you have any questions about the content of this document or you’d like to discuss product options, please speak to your local BDM or send us an enquiry on [email protected]