Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Inflation. For years, no-one gave it a moment’s thought. Now it’s on everyone’s radar. The bond market is expecting it. The stock market is worried about it. But how real a threat is it here in the UK? And how can investors handle the uncertain outlook for prices?

Much of the talk about inflation is focused on the US. It’s not surprising that investors are worried about rising prices over the pond. Joe Biden’s $1.9trn stimulus package is poised to send a cheque for $1,400 to anyone earning less than $75,000 a year. It is hard to imagine that isn’t going to push inflation higher.

But over here it’s a more nuanced picture. We are certainly in a much healthier place than our friends across the English Channel. After a shaky start dealing with the pandemic last year, we seem to have got it together with the vaccine roll-out. The light at the end of the Covid tunnel is much brighter than even a few weeks ago.

A rapid re-opening of the economy from June onwards now looks a reasonable base case in Britain. And already the signs are growing that we’re champing at the bit to open our wallets again. Booking a table in a pub garden from the middle of April looks nigh on impossible. And don’t even think about booking a staycation if you haven’t already done so. There’s little left and what there is comes with an eye-watering price tag.

But there’s a darker side to the UK economic outlook too. The trade figures for January showed a slump in cross border activity. Imports from Europe were 40% down and exports much lower too. Certainly, the figures were distorted by bureaucratic teething problems and some trade being brought forward into December to beat Brexit. But there is clearly more of a problem than the Government wants to admit.

The other big question mark is how much of the apparent boom in consumer demand will outlive the end of the Government’s furlough scheme. Parts of the economy are probably being artificially propped up by the State. As the Chancellor is keen to remind us, that cannot go on indefinitely.

The message from the Bank of England is equally balanced. Andrew Bailey, the newish Governor, said recently that he sees inflation rising towards the Bank’s 2% target over the summer, but he is confident that it will not rise to a level that threatens price stability.

However, Andy Haldane, the Bank’s chief economist has taken a more cautious view. He thinks that inflation might be hard to tame if the genie is let out of the bottle. And he says that inflation could behave very differently than it has in the past.

That makes sense. The way we lead our lives has changed significantly over the past year. There is a big gap between the lucky few who have been able to save more money while working from home and those whose jobs are threatened by the changing dynamics of the economy - whether that’s in retail, leisure or travel.

The Office for National Statistics is struggling to even collect the data it needs to measure inflation as consumer spending patterns have changed. We saw this week how the inflation watchdog has had to change the basket of goods and services it uses to measure price changes to reflect the new reality.

Inflation matters to investors for a number of reasons. In the long run it is a problem because it erodes the value of our savings and reduces the value of a fixed income. This is one of the reasons why bond yields are rising - investors require a bigger yield to compensate them for the likelihood of rising prices in future.

In the short run, too, inflation can have a big impact both on the overall level of the market but also the picture beneath the surface - the sectors and styles that perform well in a more inflationary environment are very different from those that thrive in a low inflation, low interest rate environment.

When I put together my fund picks for 2021, I was already wrestling with the question of inflation and in particular how it would impact the UK stock market. I was keen to increase my exposure to the UK in the wake of Brexit and ahead of an anticipated recovery from the pandemic because a lack of investor interest had left our domestic market looking cheap.

However, I was uncertain how the inflationary picture would evolve, and this led me to a double-headed UK market recommendation - one fund that would do well in a more inflationary environment and one that would be more resilient in a tougher climate.

Fidelity Special Situations, managed by Alex Wright, is a classic contrarian fund. It looks for out of favour shares where investors are taking an overly pessimistic view of a company’s prospects. It should be expected to play catch-up in a recovering economy, with slightly higher inflation.

The more cautious UK play is another Fidelity fund, the UK Select Fund managed by Aruna Karunathilake. Aruna looks for high quality companies with strong brands and robust balance sheets. It will probably lag Special Situations in a strong cyclical recovery but could do better if things don’t turn out quite as well as we hope.

Obviously, we don’t have a crystal ball when it comes to the outlook for the UK. For that reason, I have personally invested in both these funds as I topped up my ISA and SIPP in the run up to the end of the tax year.

Learn more about Fidelity Special Situations Fund
Learn more about Fidelity UK Select Fund
Learn more about all five of my fund picks

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. The Fidelity UK Select Fund invests in a relatively small number of companies and so may carry more risk than funds that are more diversified. The Fidelity Special Situations Fund and Fidelity UK Select Fund can invest in overseas markets, so the value of investments can be affected by changes in currency exchange rates. Both funds use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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