Exploring the Factors Behind the High UK Inflation Rate and how raising interest rates helps to tackle inflation.
What is the current UK inflation rate and what factors are contributing to its high levels?
The rate of price increases has decreased to 7.9% in the year leading up to June, down from 8.7% in May. While food inflation, particularly on items like sugar, olive oil, and cooking sauces, has somewhat subsided, it still remains notably high at 17.3%. In an effort to curb the rapid rise in prices, the Bank of England has implemented a series of 13 interest rate hikes, bringing the rate to 5%.
The Office for National Statistics (ONS) tracks the costs of numerous everyday items within a symbolic “basket of goods,” which is regularly updated to reflect changing consumer preferences. Notable additions include frozen berries, while items like alcopops have been removed.
Each month’s inflation data showcases how much prices have surged compared to the same period the previous year. The widely used measurement for inflation is the Consumer Prices Index (CPI), which was recorded at 7.9% in the year leading up to June, down from 8.7% in May and April.
Core inflation, which excludes energy, food, alcohol, and tobacco prices, stood at 6.9% in June, a decline from 7.1% in May, which had been the highest since 1992. The Bank of England takes both this core inflation figure and the headline inflation data into account when deliberating changes to interest rates.
The escalation of food and energy expenses has played a significant role in driving inflation upward. After the post-Covid return to normalcy, there was an increased demand for oil and gas. Concurrently, the conflict in Ukraine disrupted Russia’s supply, exerting additional pressure on prices. This situation, coupled with a reduced grain supply due to the war, contributed to elevated global food prices. The UK experienced a compounding effect in February, with a shortage of salad and vegetables leading to a 45-year high in food inflation. Furthermore, alcohol prices in restaurants and pubs also witnessed a surge.
Despite the Bank of England’s target of maintaining inflation at 2%, the current rate significantly surpasses that mark. A conventional response to mounting inflation involves raising interest rates, which results in increased borrowing costs and potentially higher mortgage payments for some individuals. Savings rates may also rise. A decrease in consumer spending due to reduced disposable income leads to decreased demand for goods, thereby slowing price increases. Additionally, businesses may borrow less, potentially leading to job cuts. In June, the Bank of England executed its 13th consecutive interest rate hike, pushing the main rate to 5%.
However, when inflation is driven by factors like global energy prices, the Bank’s actions might not be sufficient to effectively mitigate its impact.
Many individuals are struggling to keep up with rising prices. While regular pay grew by 7.3% between March and May compared to the previous year, when accounting for inflation, it actually decreased by 0.8%. Labor unions contend that wages should reflect the cost of living, and some workers have engaged in strikes over pay. Conversely, the government argues that significant pay increases could potentially exacerbate inflation by prompting companies to raise prices.
It’s important to note that lower inflation doesn’t entail price decreases; rather, it indicates a slower rate of price growth. The Bank of England projects that inflation will decline to 5% by the end of 2023, deviating from the earlier anticipation of 4%. Bank Governor Andrew Bailey emphasizes the importance of bringing price increases back in line with the 2% target, underlining that people should have confidence in the enduring value of their hard-earned money. However, he acknowledges that price inflation has proven to be more persistent than previously anticipated.
The Office for Budget Responsibility (OBR), responsible for evaluating government economic plans, had previously predicted that inflation would decrease to 2.9% by the end of the year. In January, Prime Minister Rishi Sunak articulated the government’s commitment to halve inflation by the end of 2023 as part of its core pledges.
Source: BBC News