Written by: Hannah Williams
As concerns about the Omicron variant wane, the UK is facing another important issue. This is the steep rise in inflation rates that became prevalent towards the end of the year. In December, inflation reached 5.4%, the highest it has been since March 1992. This prompted the Bank of England to increase interest rates to 0.25% from their record lows in order to curb this inflationary pressure. This article shall explore inflation rates and looks at how rising rates could affect households.
What is Inflation?
Inflation is the rate of increase in the prices for goods and services over a certain time period. This is usually in comparison with the previous month. In the UK, inflation is commonly measured using the Consumer Price Index (CPI) or the Retail Price Index (RPI), both of which measure price increases for a basket of common goods and services like food and transport. The Bank of England has set the UK’s target inflation rate at around 2%, as it ensures that increase is fairly low and stable. If inflation is too volatile, businesses and consumers may have difficulty in planning their spending. If inflation is too low, then this indicates that there is not enough demand for goods and services, ultimately leading to weak economic growth. On the other hand, if inflation rises too rapidly, then the cost of living increases and households may struggle to continue with their usual spending habits, harming economic growth.
The Current Rate
As stated, inflation has reached its highest rate since 1992 and so the Bank of England is attempting to fix this problem by raising interest rates. This will discourage borrowing and should in theory reduce inflation. However, this is easier said than done. It has been suggested that the biggest factor contributing to this surge in inflation has come from the steep rising in wholesale gas prices. Wholesale gas prices rose 250% in 2021, while at the petrol pumps, drivers saw a 25% increase in the price to fill their tanks. This steep increase is resulting in concern for households who will face higher energy bills and food price increases. But crucially, this means inflation is not rising due to excess demand but rather due to the increasing cost of supply. Therefore, any fiscal measures to stem demand may not successfully resolve the problem.
The Response
The Bank of England’s desire to protect economic recovery in light of the damage caused by previous Covid lockdowns has been echoed by Chancellor Rishi Sunak. Last month, he stated that “The most important thing we can do to safeguard the economic recovery is for everyone to get boosted now” (The Guardian) in order to reduce the effects of the new variant. He also announced government plans to spend billions to support living standards and provide help for the most vulnerable people. Whilst this provides some help for those who may be struggling, with such large price increases without the matching pay rises, this is not going to solve the problem alone.
According to Janine Boshoff who is an economist at the National Institute of Economic and Social Research, the current inflation rate is likely going to persist and remain higher than 5% over the course of the first half of 2022 (NIESR).
Her concerns are reiterated by Kitty Ussher, a chief economist at the Institute of Directors. Ussher states that businesses expect prices to rise in 2022 and that the government are “making matters worse” by increasing national insurance payments in April. She continues to say that this increase “…will add further fuel to the inflationary fire” (The Guardian) that the UK is currently facing.
Another who suggests that without the Bank’s response in the form of interest rate changes inflation would remain very high is Patt Mcfadden, Labour’s shadow chief secretary to the Treasury. He contends that “instead of taking action, the government are looking the other way, blaming ‘global problems’ while they trap us in a high-tax, low-growth cycle.” (Labour) As a result, inflation is likely to remain high and thus affect households in an already expensive time of year.
Conclusion
It appears as though inflation rates will remain high for longer than desired due to the global energy cost supply pressures. Although the Bank of England has already increased interest rates, the situation must be watched closely in order to ensure both households and the economy are protected. If the outcome is as predicted by many experts, the next 12 months forecast tough times for many who are already stretched by current prices and potential future COVID-19 restrictions.
