ALEX BRUMMER: With inflation hitting a 30-year high, things will get worse before they get better… but the longterm outlook is not as grim as it seems
At 5.4 per cent, the annual rise in UK consumer prices is at its highest level in 30 years.
But the long-term outlook is not as grim as it first appears.
How did we get here?
The surge in the cost of living can be attributed to the economic growth spurt the world is experiencing post-pandemic.
As global markets have recovered, bottlenecks have emerged in the supply of raw materials from timber and iron to the ingredients which go into making our food.
The upward pressure on prices this created has been compounded by rising energy costs.
As the West transitions from fossil fuels to renewable sources of energy, it relies on comparatively less polluting energy such as natural gas to keep the lights on when wind, tidal, solar and nuclear power fail to meet demand.
ALEX BRUMMER: What is certain is that things will get worse before they get better. The energy price cap will expire in April, triggering a rise in fuel bills of possibly as much as 43 per cent, leading to a full 1 per cent rise in consumer price inflation this spring, with a peak of 7 per cent forecast (file image)
An ONS graph of the Consumer Prices Index including owner occupiers’ housing costs (CPIH), the Consumer Prices Index (CPI) and the owner occupiers’ housing costs (OOH) component
Inflation is now at historic highs. Pictured: Graph showing inflation from 1992 up to the current date, based on ONS data
Unfortunately, gas stocks are in short supply due to a cold winter, a largely windless summer, and increased demand from resurgent Asian economies – especially China.
There are also suspicions that Russia – the world’s second biggest gas producer – is withholding supplies as it seeks to put pressure on Europe over issues such as its threatened invasion of Ukraine.
As the UK is one of Europe’s biggest users of natural gas – around 85 per cent of homes have gas central heating, and it generates a third of our electricity – this concatenation of circumstances has hit us hard, helping to drive up inflation to 5.4 per cent.
How bad will it get?
What is certain is that things will get worse before they get better. The energy price cap will expire in April, triggering a rise in fuel bills of possibly as much as 43 per cent, leading to a full 1 per cent rise in consumer price inflation this spring, with a peak of 7 per cent forecast.
But the rate of rise in producer, or wholesale prices, decreased in December from 15.2 per cent year-on-year to 13.5 per cent, a trend which is expected to continue.
Meanwhile, pay packets are getting lighter in spite of a drop in unemployment to just 4.1 per cent of the workforce.
In November (the last month for which data is available), average earnings were 1 per cent lower than a year earlier, increasing the pressure on household budgets.
But the current bout of higher prices has not (so far) led to the series of industrial disputes and inflation-busting wage increases that caused the great inflation of the 1970s and the 1980s.
How will we escape from it?
Central banks, rather than governments, are responsible for taming inflation. Pre-Covid, the Bank of England was successful in holding inflation at or around the Treasury-set target of 2 per cent.
The Bank began the process of restraining prices by raising the interest rate from the super-low level of 0.1 per cent to 0.25 per cent in December.
With prices still rising, the markets forecast a further increase when the Bank’s interest rate-setting committee meets next month.
Although the Bank cannot do anything directly about curbing energy prices, raising interest rates helps in two ways.
Firstly, it curbs demand which means businesses are more likely to absorb price increases than pass them on to consumers.
Secondly, the prospect of higher interest rates has already strengthened the value of sterling – and a stronger pound cuts the cost of imported goods including natural gas and fuel.
A restoration of normal supply chains, as pressure on shipping fleets and ports eases, should see inflation drop back to lower levels in the second half of 2022.