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  • Writer's pictureElaine Hua

UK Inflation

Updated: Aug 29, 2022

Written by Elaine Hua on 22/08/22

Image source: Wix media

Introduction:

The UK is experiencing the greatest inflation in decades. The Consumer Price Index (CPI), including owner’s occupiers’ house costs (CPIH), rose by 9.4% in the 12 months to June 2022, marking the highest annual CPI rise since 1997. Fuel and food are the main consumer items impacting the rapid rise in CPI and CPIH. This blog will consider the causes of inflation, as well as its impact on various industries and whether the government's reaction is effective.


Understanding UK Inflation

1. How do you know when there is inflation?

  • In the UK, the government uses CPI to estimate inflation by the UK’s Office for National Statistics by selecting a group of consumer goods which best represent the spending habits of UK citizens. The CPI is the change in the total cost of this so-called ‘shopping basket’. (Trivia: doughnuts were removed from the shopping basket this year, I guess Brits don’t like them anymore)

  • CPIH is also used to measure inflation. It is a more comprehensive measure that takes into account costs associated with owning, maintaining, and living in one’s own home, including aspects such as council tax.

2. What caused UK inflation this time?

  • There are various factors causing inflation.

  1. Supply issues due to COVID-19. Covid restrictions caused factories to close, and impeded usual cross-border businesses. This means suppliers are facing difficulties exporting goods, as evident by the CPI rise of 9.8% in food prices, the highest since 2009.

  2. The decrease in globalization (US-China trade war, Ukraine). Globalization means that producers which produce goods the cheapest gain global attention. After the Ukrainian war began, gas sanctions were imposed on Russia, one of the biggest fuel exporters in the world. The effect of the sanctions on inflation is evident in the CPI breakdown of June 2022. The annual increase in transport price of 15.2% in June 2022, was a rapid rise from minus 1.5% in June 2020. The increased price of transport was caused by the 42.3% rise in motor fuel, which is the highest since 1989; similar impacts were seen on the prices of petrol and diesel. Despite the UK only previously importing 4% of their fuel from Russia (compared to the 40% in Europe), UK fuel prices have been greatly affected by the rising cost of energy globally.


Most recent developments:

  • What did the UK government do to solve the inflation and is it effective?

    • UK interest rates were raised by the Bank of England to 1.75% in August.

    • To gauge its potential success, we should consider whether the cause of inflation is within the UK or not. If it is within, when the economy is overheating, then raising the interest rate may be successful as it increases the cost of borrowing, causing people to borrow less, spend less, and save more as they receive a higher return on bank deposits. However, this increases the cost of borrowing for businesses, discouraging them from borrowing to invest. Raising interest rates would only be effective if the inflation is caused internally.

  • But, is the current inflation in the UK caused domestically?

    • As previously mentioned, the cause of inflation is likely from outside the UK, therefore, increasing the interest rate could potentially put the UK economy into recession. This results in stagflation — a stagnant economy with high inflation and unemployment rate. The Bank of England may find itself in a dilemma where it wants to increase interest rates to control inflation, but it also doesn’t want to put off the business to borrow money for the business.


IMPACT:

Impact on YOU

  • Higher living costs and energy bills

Impact on financial and legal services

  • High inflation decreases confidence, and fears of a recession in the global economy, this will decrease people's confidence in investing in stocks and shares.

Impact on the job market

  • Workers may demand higher wages as the CPI and CPIH increase. Their employer may then increase the price of their goods to allow for increased wages. They may also be less willing to employ new employers.

Wider future impacts – will the inflation continue/ come down?

  • Inflation is currently at 10%, economists estimate that inflation will come down to 2-4% within two years (with 2% being the target for inflation).

  • Some economists say ‘what will stop inflation is inflation’. This means that, for example, as gas is expensive now and people still spend more money on it, causing them to spend less on other goods (recreation and clothing, which in the CPI report in June 2022 experienced a decrease of -0.02% and -0.05% respectively). If demand decreases, a deflationary effect is produced and inflation eventually burns itself out.

  • The Bank of England estimates that inflation will decrease as factories open, and imports increase.


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