3 of the highest-yielding FTSE 100 shares

One of the major challenges facing investors is how to generate an income return which beats inflation. This has been a problem since interest rates declined to historic lows following the financial crisis, but is now even tougher because of the rise in inflation. While interest rates could realistically edge upwards in future years, higher-yielding shares could continue to be the best solution.

Inflation

Inflation currently stands at 2.9%. This has risen more than 5x since the EU referendum, with the decision to leave the EU being a key reason for its increase. Confidence regarding the UK’s economic outlook has deteriorated, leaving the pound weaker by around 14% versus the dollar since a year ago. This has pushed import prices higher, which has gradually been passed on to end consumers via higher prices.

Interest rates

In theory, the effect of a rising inflation rate on interest rates is likely to be positive. The reasons for this include a desire to curb inflation to prevent an overheating of the economy, as well as less requirement for the stimulus provided by a lower interest rate because of a weaker currency. In other words, the pound’s depreciation has provided the UK economy with a stimulus, with exporters now more competitive than they were a year ago.


Therefore, interest rates look set to rise over the medium term. At the most recent MPC meeting, the vote on whether to increase rates was close. Although it was decided to keep rates at 0.25%, the split between members was 5-3. This suggests a tightening of monetary policy could be ahead.

Dividends

However, the reality is that the UK economy faces a large amount of uncertainty from Brexit. This could slow the rate of increase in interest rates in the next couple of years, as the Bank of England may wish to avoid damaging the UK’s GDP growth rate, or raising the unemployment rate.

In this scenario, dividend shares such as HSBC (LON:HSBA), Vodafone (LON:VOD) and Shell (LON:RDSB) may prove highly valuable to investors seeking to beat inflation. They all yield at least 2x the rate of inflation. Further, all three stocks have clear dividend growth potential.

For example, Shell is expected to increase its free cash flow due in part to the recent acquisition of BG Group, as well as a lower cost base. HSBC is well-positioned in Asia to capitalise on rising wealth and demand for financial services products. Similarly, Vodafone’s investment strategy and recent acquisitions mean it is expected to post double-digit earnings growth next year.

Pragmatism

While interest rates could move higher over the next few years, the speed at which they rise may mean that cash fails to offer a real return for investors. Therefore, obtaining a sustainable and high income return which remains ahead of inflation may continue to be challenging.

Stocks such as Vodafone, Shell and HSBC could be worthwhile options, while the latest edition of Master Investor Magazine focuses on other means of generating high income returns.