High inflation and a weak consumer leaves Bank of England in a quandary

Inflation rose to its highest level in five years last month. At 3%* it was a whole percentage point higher than the Bank of England's target rate of 2%.

While sterling has strengthened slightly over the past year, the economy is still experiencing the lag-effect of the big currency shock, that was Brexit. Company contracts are agreed in advance so we are still feeling the impact of rising prices as businesses pass on costs to consumers.

Unfortunately UK consumers are looking vulnerable. Personal debt levels are high - particularly amongst younger people - and there is evidence that big ticket purchases like new cars, white goods and sofas are being put-off, as people prefer to hold on to their money.

This means the Bank of England is stuck between a rock and a hard place. If the monetary policy committee doesn't raise interest rates in November, as is anticipated by some, inflation will continue to bite. If it does, it runs the risk of slowing the consumer even more.

With cash savings rates still languishing near zero, this means the value of cash is being eroded at its fastest rate for some time. If inflation stays this high for the next three years, £1,000 in a cash savings account could be worth as little as £920.

But for those who are happy to forgo the capital security of cash, there are ways to invest to beat inflation. Here are three possibilities:

1. Get overseas exposure

With the UK economy and currency looking a little shaky, investors could benefit from increasing their overseas exposure. M&G Global Dividend could be worth a look, as well as the new VT Chelsea Aggressive Growth fund.

2. Search for a higher yield

Because the income paid by bonds is usually fixed at the time they are issued, high or rising inflation poses a problem because it erodes the real return you receive – just like cash. To mitigate this risk you could invest in a bond fund that pays a high enough yield to provide a cushion. Aviva Investors High Yield bond, which has a yield of 4.49%** and GAM Star Credit Opportunities, which invests across the fixed income market and currently has a 4.25% yield** could be worth a look.

3. Invest in gold

Gold is viewed by many as an invaluable hedge against inflation. While the asset class works best when we have hyper-inflation, the benefits could start to be felt soon, especially if geo-political risks continue to escalate. I like BlackRock Gold & General and Old Mutual Gold & Silver funds.Please note that that gold does not pay any income and can be volatile.

Written by James Yardley, senior research analyst.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. James's views are his own and do not constitute financial advice.

*UK inflation, as measured by CPI rose to 3% in September 2017, according to the Office of national Statistics. **Source: FE Analytics as at 17 October 2017