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August’s consumer price index (CPI) inflation rose to 3.1% from 2.9% this morning (16 September), a five-month high. This has caused some concern among investors, given the contribution from higher energy costs.
However, higher inflation isn’t bad news for all UK shares. Here are some that could actually be fine with the outlook of higher prices.
Finding the winners
At a sector level, I see three areas that could do well. Energy’s one of the clearest direct beneficiaries, simply because higher inflation is being driven mostly by elevated oil prices.
The same higher oil prices pushing inflation higher can increase upstream earnings and cash flow for oil producers. Of course, for FTSE 100 giants such as Shell and BP, the UK inflation number itself isn’t what helps them. After all, they’re international in nature and serve many markets. But if inflation keeps rising because of the underlying oil price shock, that will help energy companies.
Banks are another area, again by thinking beyond the initial inflation headline. Persistent inflation reduces the probability of interest rates falling and, if anything, will see the UK base rate rise. That should support bank net interest income, which is the biggest revenue source for most major UK banks such as Barclays and Lloyds.
Of course, very high rates eventually become a negative through weaker loan demand and higher defaults. This is something to keep in mind, although I don’t think we’re anywhere close to this risk for the moment.
A different slant
A third interesting angle is insurers and asset managers, which I think is an overlooked area. At a specific level, investors could consider Legal & General (LSE:LGEN). The stock’s up 23% in the past year and has a dividend yield of 7.31%.
High inflation could help the company because it ties into the earlier point that higher interest rates are needed to combat inflation. This translates to higher bond yields. The company takes premiums from customers and pension schemes and invests this money in assets, particularly bonds, to meet future payments.
Higher bond yields can allow the company to invest new money at more attractive rates. This can improve the economics of writing new annuity business. Higher rates can also make annuities more attractive to retirees because providers can offer better income.
Even aside from this angle, the company’s performing well regardless. First-half core operating profit increased 7%, while core operating earnings per share jumped 11%. Management now expects full-year core EPS growth to exceed the top end of its previous 6%-9% target range. Asset Management’s also improving, with fee-related earnings rising 37%.
One concern is that if we do see sharp movements in rates and credit spreads, then it can negatively affect asset valuations, while falling markets could hurt asset-management fees. But even with this concern, I think it’s a good stock to consider for investors who want to act after today’s inflation news.
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Jon Smith has no positions in the shares mentioned.
This story originally appeared on Motley Fool
