Why inflation matters | The Week UK

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Inflation in the UK has reached its highest level in four decades as prices rise by 9% a year.

The Bank of England (BoE) has warned that inflation is likely to reach as high as 10% before falling next year, with the price of food and fuel putting pressure on household budgets. 

When inflation hit 7% last month, BoE governor Andrew Bailey warned that an “apocalyptic” rise in global food prices was likely to have more of an effect on households than rising interest rates, as he sought to defend the bank from criticism by government ministers that it had not done enough to “rein in rising prices”, said the BBC

But with inflation set to rise even further, it is a long way from the BoE’s mandated 2% target.

What is inflation and how is it measured? 

Inflation is a measure of the rate at which a range of prices rise over a given period of time.

In the UK, inflation is measured by the Office for National Statistics (ONS), which notes the prices of 700 everyday items known as the “basket of goods”. 

The basket of goods is “constantly updated”, said the BBC, with items such as tinned beans and sports bras added in 2022, to reflect a “rising interest in plant-based diets and exercise”.

The price of that basket “tells us the overall price level”, known as the Consumer Prices Index (CPI), explained the Bank of England’s website. 

To calculate the rate of inflation, the cost of the basket – the level of CPI – is compared with the price of the basket on the same date last year. The change in the price level over the year is the rate of inflation.

Why is inflation so high right now?

Inflation has risen by 9% in the 12 months to April, up from 7% in March. It has risen for a number of reasons, according to the BoE.

In part, prices have risen because of the difficulties in getting goods to customers as economies around the world recover from the Covid-19 pandemic. This has pushed up the price of goods, “especially for goods coming from abroad”.

The Russian invasion of Ukraine has also led to a large increase in the price of energy and food. Lockdowns in China, which is still pursuing a policy of zero-Covid, also means it is harder to import some goods into the UK.

It is these two factors that “explain the large majority of the increase in inflation” said the BoE

The price of services in the UK is also going up due to low unemployment and a strong labour market, leading to an increase in wages, which in turn leads to higher costs in the service sector.

But not everyone is seeing an increase in their pay packet. In fact, average pay increases are not keeping pace with inflation. Figures from the ONS show that wages, excluding bonuses, rose by 4.2% between January and March. But when you take inflation into account, regular pay actually fell by 1.2% compared to last year. 

What can be done to tackle inflation?

The “Goldilocks and the Three Bears analogy” is a useful tool when trying to understand why inflation is important, said HuffPost. If inflation is too low, then economic growth is “cold” and the economy won’t grow. Too high, and the economy is too “hot” and will grow too quickly – leading to rocketing prices. 

“Much like that third bowl of porridge” the ideal inflation rate is around 2%, keeping inflation low and stable, which is “just right” for the economy. 

The BoE’s “traditional response” to rising inflation is to raise interest rates, said the BBC. While this can benefit savers, it means that “some people with mortgages see their monthly payments go up”.

However, because much of the UK’s current inflation is caused by external factors, like rising global energy prices, “there is a limit as to how effective UK interest rate rises can be in curbing inflation”, said the broadcaster.

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