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17 Dec 2021

Inflation - What's Going On?

The Office for National Statistics (ONS) published data showing that twelve-month inflation on the consumer Prices Index (CPI) was at a new ten year high of 5.1% in November. On the old measure, still used on rail fares and student loans for example, the Retail Prices Index (RPI) has hit 7.1% for the twelve month period to November.

The effects of Covid-19 were associated with inflation at or below 1% over much of the crisis period. Indeed, as recently as March 2021, CPI inflation was as low as 0.7%.

Inflation has been affected by global developments, particularly the economic recovery from the worst of the pandemic and supply constraints in certain sectors.

The recent pickup in CPI inflation is partly due to low prices, as an impact of Covid 19 in the Spring and Summer of 2020. For example, catering services inflation rose to 7.9% in August 2021, partly due to the Eat Out to Help Out scheme, which reduced prices in August 2020. The temporarily reduced VAT rate for hospitality, holiday accommodation and attractions has also dropped out of the twelve-month inflation calculation.

In addition, energy prices collapsed in spring 2020 and have risen since April 2021 accounting for 1% of the CPI inflation between 2021 Q1 and August.

There has been a global shift in demand to goods, away from services during the pandemic, and the increasing costs associated with production and distribution have resulted in higher goods prices.

Finally constraints on supply have been increasing, which has created supply bottlenecks and in turn raised costs. For example, supply shortages of semiconductors, has disrupted new car production, which has led to an increase in demand in the used car market. Twelve month used car price inflation rose to 27.1% in November.

What is the outlook for inflation?

Primarily due to the elevated energy price, the Bank of England had anticipated CPI inflation to rise slightly above 4% in Q4 2021 and could remain above 4% into Q2 2022.

There is uncertainty around the outlook for the labour market, there are signs that commodity prices will stabilise, supply shortages will ease and global demand will rebalance away from goods back to services. The Bank of England’s Monetary Policy Committee believe inflation will return to around 2% in the medium term and the current elevated global cost pressures will prove transitory.

What is inflation?

Think of a shopping basket filled with things we typically buy. Inflation is the rate of increase in the prices of the items in that basket.

It is the Bank of England’s job to make sure that there is a limit to prices rising, as this supports a stable and healthy economy.

The Bank of England has a 2% target for inflation, set by the Government. The Bank of England use a key interest rate in the economy, known as Bank rate to control inflation.

If inflation looks like it will go above the 2% target, they might increase interest rates, so people spend less, which tends to reduce inflation.

If inflation looks like it will fall below the 2% target, they might cut interest rates to boost spending in the economy and help inflation to rise.

Since the Bank of England began targeting inflation in 1997, inflation has averaged about 2%.

Today, 16th December 2021, the Bank of England has raised interest rates by 0.15% to 0.25%. The first increase for three years. We view this as the first step in a longer policy movement. The current inflation spike is driven on the whole by global factors and so higher interest rates are unlikely to curb further inflation increases in the short term.

How have prices changed?

Over the past 30 years, the price of a typical basket of goods and services has roughly doubled. Some items have risen faster than that and some items have hardly changed at all.

For example the price of a pint of milk has doubled since 1990. In 1990 you would have paid around 25p for a pint of milk, today you will pay around 50p. This works out as an increase of around 2% each year. Whereas, the cost of watching a football match has gone through the roof! Over the same period the average price of a match ticket has increased from around £5 in 1990 to around £50 in 2021. Double that at some clubs. This is an increase of around 8% each year.

Why is inflation important and what can I do about it?

To maintain our standard of living, we need our income to keep up with our expenditure. If our expenditure continues to rise and our income does not keep up, we need to change the way we live.

The obvious example of the impact of inflation is cash deposit interest rates.

If you are receiving interest on your cash savings of for example 0.5%, but inflation is 3%, the value and the purchasing power of your savings is going down in real terms.
The key is to ensure that overall the value of your income and assets at least match the increase in inflation. To do that you need advice, likely investment advice. You certainly do not want to leave all your hard earnt cash sat on deposit for a long time while inflation eats away at it.

If you would like to discuss the impact of inflation on your own assets, income or expenditure, please get in touch with your adviser. 

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