Inflation is rising at exceptional levels and many people are understandably worried. To properly grasp why inflation is a problem it is first important to understand inflation itself. Here we’ll look more closely at inflation and also the impact of the rapid rise we’re currently experiencing. Below we’ll explore:
- What is Inflation?
- Is high inflation a problem?
- Why is the rate of inflation so high right now?
- When will inflation start to fall?
- What does high inflation mean for me?
What is inflation?
Inflation is a sustained increase in overall price. As an economy grows, both businesses and consumers spend more money on services and products. Moderate inflation is associated with economic growth but high inflation is often the sign of an overheated economy. Inflation increases when the demand outstrips the supply of goods and therefore producers have to raise their prices.
We know the rate of inflation in the UK because the Office for National Statistics checks the prices of a set range of items in a “ basket” of both goods and services. They record the cost of over 700 things that people regularly buy including bread and bus tickets but also more significant purchases like holidays and cars.
The price of this basket gives us the overall price level, known as a Consumer Price Index. To calculate the rate of inflation the Office for National Statistics then compares this Consumer Price Index with what it was 12 months previously. The change in price level is the current rate of inflation.
The Bank of England has a handy inflation calculator which can give you an understanding of how prices have changed over time. It can be quite shocking to see how much things have changed.
Understanding Inflation %
Inflation is presented as a percentage, which means out of 100.
For example, If inflation is 2.5% then something that used to cost £10 one year now costs £10.25. The larger the amount you start with, the bigger the increase of course so high rates of inflation can be a worry for consumers.
The current rate of inflation in the UK is 9.4%. This means things are 9.4% more expensive than they were 12 months ago.
Is high inflation a problem?
A stable and steady rate of inflation helps to create a healthy economy. In the UK and most other countries the government sets a target for how much prices should go up each year. In the UK this target is 2%. The Bank of England is responsible for achieving this target.
Some inflation is usually seen as a positive, but high and unstable levels of inflation can be damaging to the economy and people’s lives. When prices are unpredictable people can struggle to manage their money and know when or how to invest or save.
There have been examples of extreme and volatile inflation in the past that have led to economic collapse. In Zimbabwe from 2007-2009 price levels increased by approximately 80bn per cent in a single month, leading to economic stagnation. This type of situation is extreme but concerns around high inflation are certainly valid.
Why is the rate of inflation so high right now?
High inflation in the UK right now is fuelled by a number of factors. The spiralling cost of energy is one of the main factors. Similarly, the Russian invasion of Ukraine has also led to large increases in the price of gas, with a knock-on effect on the economy. The price of gas has doubled since May and it only seems to be getting higher.
The Coronavirus pandemic has also impacted inflation. People began buying more goods during this period but retailers and producers struggled to keep up with demand which in turn led to higher prices.
The UK is also experiencing high rates of job vacancies. Fewer people are seeking work following the pandemic so employers have to do more, like increasing wages, to attract employees and this means they then have to consider increasing their prices to cover their increased wage bill.
A complex range of factors is responsible for rising inflation in the UK.
When will inflation start to fall?
It can be hard to predict when things will change. The Bank of England forecast inflation will start to fall in 2023. They believe it is unlikely that the cost of fuel and goods from abroad will continue to increase at the same pace.
The Bank of England maintains its target of 2% for inflation and they hope to be close to this target in around 2 years.
What does high inflation mean for me?
You are probably already feeling the impact of high inflation on your day to day life. The most obvious signs are the increased cost of food and fuel. Petrol prices are higher than before and often salaries do not keep up with inflation, therefore household finances do not stretch as far as they did.
High inflation can also impact the value of your savings. High inflation reduces the “real” value of your savings. It is important to try and get the best possible interest rate for your savings and check in on the rate of inflation regularly too.
Living with high inflation can be worrying, money doesn’t go as far as it used to and employers can’t simply increase wages to meet their employees’ needs as they have costs and expenses too. As the economic and political climate settles, we can only hope that inflation settles too.
Living on a reliable budget and finding ways to be thrifty and save help to ensure you don’t feel the impact of high inflation too strongly.