Unpacking The Factors Behind High Inflation In The UK

A spike in inflation that has many British citizens feeling the pain in their wallets has been plaguing the country in recent months. It's crucial to understand the reasons behind why costs for basic products and services keep rising. In this article, we'll examine the main factors driving this and its effects on the economy and consumers.

But before we start, it's important to understand what inflation means. When prices for goods and services consistently rise over time, it is called inflation. It reduces the purchasing power of money, raising living expenses and perhaps affecting numerous economic factors, such as interest rates and consumer spending.

Why Does The UK's Inflation Rate Seem So High?

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This year, up to July, the pace of price growth decreased from 7.9% in June to 6.8%. Although it has decreased, food inflation on commodities like milk, bread, and cereals is still high at 14.9%.

Inflation as measured by the Consumer Prices Index (CPI) is expected to be 6.8% in the year to July 2023, down from 7.9% in the previous month, according to the Office for National Statistics' (ONS) most recent report.

The Bank of England raised interest rates 14 times, reaching 5.25%, to assist moderate price increases.

What Does Inflation Mean?

A prolonged rise in the average price of goods and services over time in an economy is called inflation in economics. When there is inflation, a country's currency (such as the pound in the UK or the dollar in the US) has less purchasing power per unit than it did previously. In other words, inflation reduces the value of money as a medium of exchange.

The amount that prices have risen over a given period, generally a year, is indicated by inflation, typically stated as an annual percentage rate. It is calculated using a variety of price indices, including the Consumer Price Index (CPI) and the Producer Price Index (PPI), which monitor changes in the costs of a selection of goods and services that consumers often purchase.

If a milk bottle costs ?1 today but costs ?1.05 tomorrow, milk inflation is 5% annually.

Measurement Of The Inflation Rate In The UK: How Is It Determined?

Credit: National Statistics

The Office for National Statistics (ONS) keeps track of the costs for hundreds of commonplace items in a fictitious "basket of goods." The shopping cart is often modified to follow market trends; the most recent additions include frozen berries and the removal of alcopops.

The monthly inflation rate demonstrates how much these costs have increased since the same time last year. The Consumer Prices Index (CPI) is the primary "headline" measure of inflation. However, it can be calculated in several different ways.

The CPI decreased from 7.9% in June to 6.8% in the year to July.

Inflation: Why Is It So High?

Previous BoE predictions had indicated that the UK's inflation rates would moderate, dropping to slightly over 5% in the fourth quarter of 2023 and to below its target of 2% in the first quarter of 2025.

Inflation rates have, however, skyrocketed due to significant price increases across the economy, energy subsidies, and Britain's troubled post-pandemic job market. Following Russia's full-scale invasion of Ukraine in February 2022, which caused natural gas prices to surge across Europe, inflation in the UK also drastically increased.

The Office for National Statistics reported that core inflation unexpectedly increased to 7.1 percent from 6.8 percent, its highest level since March 1992. Core inflation is a measure that excludes volatile food, energy, alcohol, and tobacco prices, which the BoE regards as a fair pointer of underlying price pressures.

Services inflation, a key indicator of underlying pressures strongly driven by swiftly growing salaries and Britain's challenging post-pandemic labor market, also hit its highest level since 1992 at 7.4 percent.

"The cost of airfares rose by more than a year ago and is at a higher level than usual for May," said Grant Fitzner, chief economist at the Office for National Statistics.

However, the inflation rate for food and drink prices decreased from 19% in April to 18.3%. In the meantime, producer price inflation decreased by 2.9 percent in the year to May, down from an increase of 5.2 percent in April, much more dramatically than economists had anticipated.

Credit: Bank Of England

When It Comes To Fighting Inflation, How Does Raising Interest Rates Help?

Although the Bank of England aims to keep inflation at 2%, the present rate is far higher. Interest rates are typically raised as a reaction to growing inflation. Due to the increased cost of borrowing, certain borrowers who have mortgages may experience an increase in their monthly payments. Additionally, some saving rates rise.

People buy fewer things when they have less money to spend, which decreases the demand for commodities and slows price increases. Businesses may also reduce the number of employees as a result of borrowing less money.

The Bank of England raised interest rates in June for the fourteenth consecutive time, bringing the benchmark rate to 5.25%.

How Soon Will Inflation Decrease?

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Lower inflation does not imply lower prices. Simply put, they ascend more slowly. Instead of the 4% it had anticipated, the Bank of England expects inflation to reach 5% by the end of 2023.

People "should trust that their hard-earned money maintains its value," according to Bank Governor Andrew Bailey. Therefore, it is "crucial that we see the job through" and bring price rises back to the 2% target.

However, he acknowledged that price inflation was "more sticky than initially anticipated."

The Office for Budget Responsibility (OBR), which evaluates the government's economic strategies, had earlier anticipated that inflation would return to 2.9% by year's end.

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