Inflation rise to 3.8% is headache for chancellor but positive for struggling infrastructure funds

The annual rate of growth in the consumer prices index (CPI) jumped from 3.6% in June, the Office for National Statistics said today, its highest reading since January 2024, although well below the 11.1% high in October 2022 after the war in Ukraine saw energy costs soar.

The cost-of-living increase in July was driven by a 4.9% rise in groceries, and 3.2% uplift in transport that included a record 30.2% month-on-month hike in airfares ahead of peak summer demand.

The data lifted the pound on currency markets as traders calculated the Bank of England will be less willing to repeat another cut in interest rates in September, having trimmed base rate by 0.25% to 4% this month.

That’s a challenge for chancellor Rachel Reeves who is desperate to improve economic growth and raise voters’ living standards.

The September inflation figure will determine increases to state pension and benefits, increasing government spending when Reeves is grappling with an estimated £40bn budget shortfall.

Inflationary pressure is better news for infrastructure investment companies, however. Many of their contracts to provide facilities or energy are linked to the officially outmoded retail prices index (RPI) measure. It hit 4.8% in July, which was also an 18-month high.

RPI is still used to calculate subsidies for renewable energy funds, although not the newer guaranteed price arrangements that are secured under the auction rounds of CFDs.

Infrastructure funds point out that as inflation-linked revenues rise, it lifts their net asset values (NAVs) backing their share prices. Our note on GCP Infrastructure (GCP) this month, for example, included a table that showed 2% inflation would add 9.8p to its NAV per share.

However, inflation is just one of several inputs into fund valuations. Higher inflation often comes with higher interest rates that can push up the discount rates valuing their cash flows and depress NAVs.

Renewable funds are also struggling with falling power price forecasts and low wind generation which reduce revenues and also erode NAV.

A rise in inflation will therefore not remove the double-digit discounts to which shares in infrastructure and renewables funds have fallen, but amid their prolonged downturn it is good to see one factor become a bit more positive.