The cost of living crisis is touching people internationally. Here in the UK, rising energy bills, expensive petrol and the increase in food prices are negatively impacting people across the country, hitting the ‘least well off the hardest’. With a 40 year high of 10.1% of inflation (well beyond the Bank of England’s 2% target), pressure is building for the government to do something to help Britons bear the burden of inflation in the UK.
If you’re looking to wrap your head around inflation: what it is and why it happens, you’re in the right place. This short guide to inflation will walk you through why inflation happens, what it means, and how it affects UK consumers.
Let’s first take a look at the basics: what is inflation? Inflation isthe increase in the price of something over time. This can refer to goods or services. The current inflation rate in the UK is 10.1% (accurate at time of writing), which is a 40 year high. According to the ONS, the biggest financial crunch can be felt in transport and food prices.
One of the most common ways that inflation is measured is using the Consumer Price Index (‘CPI). This involves tracking the price of a basic ‘basket’ of everyday goods. What is contained in the basket is constantly updated to reflect changing trends and consumer habits. The ONS uses the CPI to measure and record the UK’s inflation rate. Thus the UK Consumer Price Index rose by 9.4% in June of this year. And has now risen to 10.1%.
Inflation happens for a number of reasons. It can be triggered by a rise in production costs, higher consumer demand for a certain type of product, certain governmental economic policies or national and international political or natural disasters.
Inflation causes concern for businesses, consumers, and governments because it can mean that people’s savings are less valuable than they were previously. Another critical influence of inflation on consumer spending is that purchasing power is weakened.
However, though it may seem as though your wages are increasing because of inflation, in actual fact, they are not keeping pace with price increases. Though average wages increased by 4.3% between March and May, inflation means that they have actually fallen by 2.8% when compared to a year ago.
The Ukraine-Russia war’s impacts are reverberating around the world, not least in the economic sphere. As a result of the conflict, oil and gas prices have been steadily surging and are expected to rise further from October. This is one of the main reasons that UK inflation is so high.
Additionally, if you’ve noticed that your petrol or diesel bill has been higher recently, this is because the war in Ukraine has increased the price of crude oil. Finally, food prices have also risen as a result of the war because grain production has been severely impacted.
The COVID pandemic most certainly had a deep impact on inflation rates too. According to the Bank of England, increased buying and spending during the pandemic (translating to greater demand), caused increased prices – especially on imported goods.
Though China’s stringent national COVID regulations may not appear to have anything to do with the global economy, let alone UK inflation, its impact is actually quite substantial.
The country’s tough zero-COVID stance has disrupted key transport logistics and interrupted supply chains. This has and continues to wreak havoc on freight costs and thus having a knock-on effect for global inflation rates.
Typically, the Bank of England would raise interest rates in order to tackle inflation. The impact of this is multifaceted, but the bottom line is that because interest rates are higher, borrowing becomes more costly, thus consumers have less disposable income, weakened purchasing power, and prices should stop rising. The Bank of England has therefore raised the Bank Rate of inflation to 1.75%.
However, because of the external socio-political roots of this economic crisis, it is questionable as to how effective this approach would actually be in this case.
The UK government has announced a number of measures that aim to support Britons through this cost of living crisis. The Chancellor launched support schemes worth approximately £37 billion including a £400 discount on energy bills, means tested payments of £650, a council tax rebate, a 5p reduction to fuel duty and a rise in the NI contribution threshold.
Projections vary and there is no consensus as to how long the UK economy will take to recover. The Bank of England projects that inflation will continue to rise from the autumn, peaking in the winter, and then eventually reducing down to their 2% target in two years time. However, nothing is for certain, especially when unpredictable factors such as the Ukraine-Russia War and COVID-19 are still at play.
Currently, the UK inflation rate is 10.1% (accurate at time of writing).
There are a number of factors at play that are causing inflation rates to rise. Principally, the Ukraine-Russia war and China’s Zero-Covid policy are driving prices of energy, goods and fuel up due to disrupted supply chains combined with increased demand.
As defined by investopedia.com there are three types of inflation: demand-pull, built-in and cost-push inflation.
Demand-pull inflation is where there is a more availability of money and credit which causes demand to grow ahead of the economy’s production capabilities.
Built-in inflation is where people expect current inflation rates to continue, thus leading them to continue asking for higher wages to maintain a certain quality of life. This is a vicious cycle in which current inflation therefore breeds more and more inflation.
Cost-push inflation is where high production costs drive the increase in prices, resulting in inflation.
Inflation causes increases in prices, reduced value of savings and wages, and therefore diminished purchasing power. This leads to a cost of living crisis (such as the one we are facing) and considerable financial strain, especially amongst communities that are less well off.
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