Tue, 30 May 2023

High inflation: what can we expect from this situation?

21 Apr 2022, 17:51 GMT+10

Inflation has hit its highest level for nearly 30 years, driven primarily by rising food and energy prices. It climbed to 5.4% in January 2022, the highest it has been since March 1992 according to the Office for National Statistics (ONS). In recent years inflation has been relatively stable at around 2% which is the government's target.

Inflation requires prices to rise across a 'basket' of goods and services, those most commonly bought including food items, rent, and bills, which is measured by the Consumer Price Index (CPI). When the prices of goods are irreplaceable, like food and fuel, they can affect inflation by themselves.

The CPI measure of inflation turned out to be worse than predicted. And unfortunately, it is heading even higher. The Retail Price Index, an inflation measure that is still widely used by governments and businesses, is already at an incredible 7.8%. Independent analysts fear the CPI will hit 7% in April 2022 when the energy price cap is raised again.

Inflation decreases make you buy less for the same money, as more money is needed to buy the same items. High rates of inflation mean that unless income grows at the same rate, people are worse off. Therefore, people will spend less and there will be a reduction in sales for small and also big companies.

The cause of this inflation rise

The rise in global energy prices has had a big effect on inflation. This was already happening in 2021 and has now been magnified by the war in Ukraine. High energy costs increase the cost of production and transportation of goods, having a knock-on effect on the whole economy.

The other cause was the recovery from the Covid pandemic. When economies started opening up again, people naturally wanted to start purchasing products again. But supply problems due to closed-down economies caused prices to rise. This particularly affected imported products.

There were also unexpected natural events, like flooding in Asia, that disrupted the production of electrical goods.

When will inflation come down?

The Bank of England controls inflation by raising interest rates, this means that people earn more on their savings but have to pay more for mortgages and loans. This should encourage them to save rather than spend and reduce demand for goods.

The Bank of England expects inflation to reach more than 7% by spring and then start to come down after that. "That's the reason why the current high rate of inflation won't last," the Bank said. "It's unlikely that the prices of energy and imported goods will continue to rise as rapidly as they have done recently. And this means that inflation will decline.

"We expect it to be much closer to our 2% target in two years. But even though the rate of inflation will slow down, the prices of some things may stay at a high level compared with the past."

The bank has already raised interest rates from 0.1% to 0.5% and expects to have to raise them several times more in 2022 until inflation subsides.

The consequences of high inflation

The Office of National Statistics' figures issued in January showed that average pay rises are failing to keep up with the rise in the cost of living.

The usual pay, with the exclusion of bonuses and modified for inflation, decreased to 1% in November in comparison with that very month last year.

This means that those on moderate and low incomes are likely to feel the squeeze during 2022 as their wages don't increase with inflation. An inflation rate of 5% means that a bottle of milk that cost £1 will now be £1.05, so consumers' income will be stretched as they won't get as much for their money.

The effect on businesses

Rising inflation creates a big problem for businesses. As their bills and the price of raw materials go up they need to either pass this cost onto the consumer or absorb it. Stagnant wages will result in a decrease in demand for products in the future so businesses will be reluctant to raise prices by too much.

The soaring price of fuel and a lack of delivery drivers due to Brexit and the pandemic has raised transport costs for many businesses. Those in food production and construction have also seen big hikes in the prices of raw materials.

If prolonged, this could lead to businesses struggling to make ends meet. The pandemic has already caused hardship for many businesses, with successive lockdowns. Rising business failures will, in turn, lead to increased unemployment which is bad for the economy.

Additional pressure is that to compensate for rising inflation, staff may ask for wage increases, further adding to businesses' costs. If businesses pass these costs on, that will in turn lead to more inflation.

High levels of inflation in the UK also create a challenge for businesses that export goods abroad. If inflation levels are lower in other countries than here, the goods from the UK will be comparatively more expensive, leading to a fall in demand for them.

Inflation can also make people to spend too - if prices are rising quickly there is an incentive to buy now rather than later. This in turn results in higher inflation, further decreasing the spending power of money.

Businesses are experiencing now the biggest difficulties associated with inflation for at least 30 years.

Exhibition stand contractor, Quadrant2Design, is one such business. MD Alan Jenkins said 'It's a tough climate, first we had to shut down completely during the pandemic, with no government support. Now we are seeing the costs of raw materials, bills and transport rise steeply. It's difficult not to pass these costs to the customer and we are trying to do our best to absorb them, but it is not something that can be done permanently.

What can be done to tackle inflation?

The Bank of England's typical response to rising inflation is to increase interest rates. The idea is that if it is costing more to borrow money, people will spend less, and inflation will go down.

However, if inflation is being caused by global problems raising the price of fuel and other goods, this may not be the answer.

The government could decide to cut taxes on items that are rising the fastest - such as removing VAT from energy bills. Or it could help those who need it most. Those on low incomes have been able to claim the Warm Homes discount scheme, for example, which offers the option to apply for a one-off £140 payment during the winter of 2021/22.

The soaring inflation levels in the UK create problems for both consumers and businesses. Consumers will be able to buy less with their income and businesses will face rising costs and shrinking margins, with lower demand if they pass these costs on. However as the cause of the crisis is global, raising interest rates is unlikely to have much effect. The general opinion is, however, that the global energy and goods prices will come down again, and inflation should return to normal levels by 2023.

Sign up for Memphis News

a daily newsletter full of things to discuss over drinks.and the great thing is that it's on the house!