The Virulent Strain of Inflation Engulfing the UK and the World
Inflation is like bacteria - vital for the life of an economy but the wrong kind can cause disastrous consequences for the system. It is defined as the general increase in the prices of goods and services in an economy, which in turn means that the purchasing power of the money in your pocket decreases.
Whilst inflation is always present in an economy and to a certain extent provides a necessary foundation for economic growth, soaring levels of inflation in the UK and across the world have thrown all market conditions and potential for post-pandemic recovery into disarray, with no clear resolution in sight.
A key measure for inflation in the UK is the Consumer Price Index (CPI), which measures the movement in prices for consumer goods and services. Earlier this year the CPI rose to a 40-year high of 9% annual rate, with the Bank of England warning that it could exceed 10% within the next few months. The rise in energy bills and the subsequent cost-of-living crisis have been the biggest contributor to the unprecedented rise in inflation, with global conditions like the Russia-Ukraine conflict, China’s Zero-Covid policy and other supply chain disruptions exacerbating the situation. Having already raised the energy price cap by 54% in April, energy regulator Ofgem has predicted that energy prices will increase by a further 42% in October – a difficult pill for even the most optimistic economists to swallow.
Inflation is not an uncommon occurrence, but what is most alarming this time round is the sizable impact that it has had on the global economy. Recent revelations have seen Eurozone inflation hit record levels at 8.1% at the end of May and South Korea has seen its highest rise in inflation in 15 years; it is without doubt a global phenomenon. Around the world, having just contended with a once in a lifetime - hopefully - pandemic, nations now are struggling to suppress the raging waves of inflation and the UK, much like other countries such as the USA, is having to consider inducing a recession in order to keep this outbreak under control.
To combat this persistent rise in the cost of living, the Bank of England has intervened by exploiting its best tool to control the money supply – interest rates. Higher interest rates increase the opportunity cost of holding cash and so it combats inflation by incentivising saving, rather than spending; this comes at the cost, however, of reduced economic growth. In May the Monetary Policy Committee voted 6-3 in favour of increasing the bank’s base rate to 1%, however this may change in the committee’s next meeting this month. The government has also attempted to relieve some of the strain that inflation and the cost-of-living crisis has put on families by offering a £15bn support package, which includes one-off payments of £650 to around 8 million households in receipt of welfare payments. This has been financed through a windfall tax, amassing £5bn via a profit levy on oil and gas companies. There have been disputes about whether this will lead to increasing inflation, rather than actually solving the problem, given that the stimulus would potentially be supplying more money into the economy. However, both the Prime Minister and the Chancellor disagree, using the fact that unemployment is at its lowest level since 1974 to justify the UK economy’s strong stance in the fight against inflation.
For all the words that are coming out of the mouths of politicians and bankers, there are real and serious consequences for consumers and investors. Food prices rose 6.7% in April and some in the industry have expressed their concern that they could rise up to 15% this year. Wages have suffered due to inflation; despite rising by 4.2%, in real terms regular pay has fallen by 1.2% in comparison to this time last year. Rising input prices have forced retailers and business to make the tough calls of whether to soak up the damages themselves, shielding their customers from the fallout, or raise their prices and risk a reduction in footfall, particularly amongst smaller businesses. Even the measures brought in as a response to the crisis have upended certain sectors of the economy, with mortgage payments becoming more expensive for many homeowners due to the increasing interest rates and uncertainty surrounding them.
In a high-inflation environment, investment is as risky as it gets. Stock markets around the world have faced the brunt of this crisis, with many approaching bear market territory. Stock markets are useful gauges of an economy’s overall health. Historically, property and equities have been the go-to investment opportunities when inflation has occurred. Even though deposited cash may earn more interest due to higher interest rates, any earnings are offset by the rise in prices, making any investment decisions difficult. The fate of the UK economy and those worldwide will be determined by the actions of governments and central banks, whether that be through raising interest rates or other forms of monetary policy. What is clear though is that swift action must be taken to put an end to a spiralling price crisis that for many has turned basic necessities into unaffordable luxuries.
References/ Wider Reading
Sunak statement helps reduce inflation but risks higher rate rises – Financial Times
Small UK businesses struggle to absorb soaring costs – Financial Times
Eurozone inflation hits record 8.1% - Financial Times