(MENAFN – The Conversation) UK consumer price inflation rose 3.2% year-on-year in August, the largest annual increase in nearly a decade. It was 1.2 percentage points above the number for July, making it the biggest monthly increase since the record started in 1997. Inflation is also a problem far beyond the UK: in the United States, it is currently 5.3%, for example. .
Bank of England economists conveniently attribute these large increases to temporary factors and say inflation will soon stop rising in the UK without much intervention. They point out that a year ago prices were artificially under control and as they returned to more ânormalâ levels we were destined to get high measures of inflation.
An example would be gasoline prices. Weak demand for commuting helped reduce them to around 113 pence per gallon at the pump in 2020, but as travel returned to pre-pandemic levels, increased demand for gasoline pushed prices up. at about 135 pence. Or you can watch the Eat Out to Help Out program, which lowered the prices people paid in restaurants in the summer of 2020. When the program ended, prices suddenly went up, which increased inflation.
The optimists’ argument is that these one-off changes will spill over into the system and prices will stabilize at their current levels. Yet not all price increases can be attributed to temporary factors. Deeper structural factors are also at play.
What are the causes of inflation
Inflation is measured by the Office for National Statistics, which records the prices of thousands of products. These prices are defined by an endless interaction between supply and demand in the economy (assuming the government does not step in to set prices in some way).
An abundance of surplus products or services means that prices are likely to fall, as we have seen with oil prices. On the other hand, the demand for products that cannot be fully met by supply usually pushes prices up. This has happened with hand sanitizers in 2020, for example, and more recently with used cars.
Ten years of inflation in the UK
Economics of commerce
Besides COVID, Brexit has certainly affected prices. This made trade with countries neighboring the UK more difficult and costly. This contributes to product shortages, driving up prices.
Brexit has also hampered production in the UK by alienating a percentage of EU nationals working in the country. Shortages of fruit pickers, truck drivers and NHS nurses have pushed up wages and made British production more expensive. And there is the potential for political and trade disruption between the UK and the EU, especially in Northern Ireland, which could make products and production even more expensive.
Another important structural factor for inflation is the pound sterling. The UK imports hundreds of billions of pounds of consumer goods and raw materials. A weaker pound sees the country paying more of its currency to buy goods from abroad, making those goods more expensive in pounds.
It doesn’t buy you much these days. Yulia Grigorieva
The pound has already been weakening against its rivals for several years due to economic factors such as lower productivity. This downward trajectory is also expected to continue due to political factors such as the second Scottish independence referendum and civil unrest in Northern Ireland.
Additionally, as the Bank of England continues to boost the economy with vast amounts of money through quantitative easing (QE), there should be downward pressure on the value of the pound. The only thing saving the pound from major falls is the fact that the central banks of other major currencies are doing the same – for now.
An accommodating monetary policy also potentially contributes to higher inflation for another reason. Record interest rates make consumers borrow, while QE pushes banks to lend more as it increases the value of assets on their balance sheets. This can fuel demand for products such as cars, electronics, and white goods (such as washing machines, dishwashers, and refrigerators). As a guide, although house prices are (wrongly) not factored into consumer price inflation, low interest rates have contributed to significantly higher prices in this market, as well as on the stock market.
Where do we go from here
A little inflation in an economy can be positive, as it prompts consumers to buy things before prices go up. It’s also a way to reduce government debt in real terms, which is interesting after the massive borrowing to pay for the COVID stimulus package.
High inflation is a problem though, as it erodes people’s real incomes, which means they consume less and businesses make less money. This is why the Bank of England gained independence from the British government in the 1990s, with a mandate to keep inflation around 2%.
The UK government and the Bank of England should therefore strive to address some of the longer term structural factors that can keep inflation high, especially when ‘supply shocks’ such as new variant of COVID or trade sanctions against China could further imbalance supply and demand in the short to medium term.
Shortages of people and skills in the labor market need to be addressed before UK production capacity is affected by offshoring and outsourcing of production. Thanks to Brexit, the British public voted to take control of migration, not to shut it down when necessary.
The free trade of goods and services with the neighboring continent of the United Kingdom is also essential for the long-term competitiveness of the country, but here it is true that things are difficult. The EU will never accept the existential danger of a country benefiting from its massive free market without fully subscribing to its policies and regulations. Damage control seems to be the only way forward here, which underlines the importance of reaching a lasting deal with the EU on Northern Ireland.
Finally, the Bank of England should consider taking its foot off the quantitative easing accelerator as soon as possible, before inflation expectations crystallize into further price hikes. Too much money and ultra-low interest rates not only inflate asset prices, but also stimulate corporate borrowing and provide a temporary lifeline for zombie companies, laying the groundwork for the next crisis.
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