There is no escaping inflation: Whether it’s energy, food, transport or entertainment you pay for, prices are rising – and in pace.
Again, this week’s headlines have been dominated by the latest figures – on Wednesday we were told that inflation had reached a 40-year high of 9%. Plus, there have been warnings of worse in store. But what does it all mean? We asked readers what questions they had about inflation and its impact, and have addressed them below.
First a little background.
The increase in the cost of living is captured in the monthly inflation rates reported by the Office for National Statistics. There are several different rates recorded by economists: the consumer price index (CPI), the retail price index (RPI) and the CPIH (CPI including homeowners’ expenditure on housing). It is CPI that hit 9% last month. CPIH was 7.8%, while RPI was 11.1%.
The tariffs are different because of the goods included in the price tables and also because of the way the figures are calculated. RPI tends to be the highest. It is set to be scrapped in 2030, but is currently still used to set student loan rates and annual increases in train prices.
Q Would 0% inflation be good?
Hilary Osborne: Inflation is the rate at which prices rise – it does not tell you how high prices are historically, but how much higher or lower they are than last year. So if inflation this time next year is 0%, it means that prices will still be higher than in the same period in 2021.
That said, no one is aiming to bring inflation to 0% or even below. Inflation of 2% is generally considered to be good – this is the rate that the Bank of England and other central banks are aiming for. This rate is high enough to encourage people not to sit on all their cash and wait for prices to fall, but low enough to allow people to plan and wages to keep up.
Banks generally respond to rising inflation by adjusting interest rates upwards – the idea is that this will encourage people to save their money instead of spending it and reduce the demand for goods and services.
Q Current inflation is not caused by an increase in demand or in wages – it is caused by an increase in supply costs. This is partly caused by the war and Covid and the consequent shortages and supply chain problems but is the real problem not that commodity-producing companies exploit their almost monopoly positions?
Larry Elliott: this is just for the money. Traditionally, higher interest rates work when the economy overheats, and – apart from the housing market – there is no evidence that it is. The UK’s national output of goods and services is just above its pre-pandemic levels, so in fact two years of growth have been lost.
The Bank of England has admitted that it can not do much in the face of rising energy costs and initially thought it would be possible to wait for inflation to fall without doing much. It has now been intimidated by evidence that inflation will remain higher for longer, and some signs that higher energy prices are taking hold in other parts of the economy. The risk of driving Britain into recession is clearly present. An unexpected tax on energy companies is going to happen, whatever the government says at the moment.
Q I am a first time buyer who has saved almost my entire target deposit. I would like to go up the real estate ladder to stop paying rent and because my money is currently in the bank and doing nothing. Is it a wise time to buy, or should I wait?
SCYTHE: the housing market has started to cool down a bit, but it is too early to say that there will be a housing crash. For this to happen, there must be a sharp rise in mortgage rates and unemployment rather than the more modest increases currently forecast. That said, people’s willingness to take on large financial obligations at the moment is understandably weak, suggesting that house prices are not going to do much in the next year or so.
Sp. Why is the annual increase in state pensions based on the CPI rate in September each year? Would an average of inflation taken over the calendar year be a fairer rate of increase in April?
HAY: September figures are used to give the government time to put the change in payments up. Steve Webb, a former pension minister who is now a partner in the consulting firm LCP, says that after the September figures were published in October, the Ministry of Labor and Pensions should look at its data and publish plans for parliament – usually in the November budget. The actual legislation to implement the changes will not be debated until the beginning of the following year.
“There’s a lot of parliamentary process going through (we’re talking billions of pounds of public spending) and time to change rates, especially for older benefits on old computer systems,” he says.
Each month’s figures are based on a comparison with prices the year before, so 12 – month changes are always taken into account. When inflation is fairly stable, September figures are undoubtedly as good as any. Normally, the triple lock – the promise that pensions will rise in line with inflation, average earnings or 2.5% – removes some of the ups and downs, but it was not used this year.
In fact, a simple average of last year’s monthly CPI rates results in a smaller increase than the 3.1% increase this year because inflation was below 1% in the first part of 2021.
I work as a postman and we have only been offered a pay rise of 3.5%. If we get a bigger increase, will it have an impact on inflation?
SCYTHE: higher wage allocations do not cause inflation. Wages are a price like any other and reflect market forces. Higher wages will alleviate some (but not all) of the living standards caused by rising inflation and should encourage people who are not currently working to apply for jobs. It should help alleviate labor shortages, one of the supply-side constraints affecting the economy.
Q My son is buying a house. I am concerned that the likely rise in mortgage rates due to inflation will affect his budget. Is there anyone who can give us a guide on the prospects for top interest rates?
HAY: Unfortunately, no one can tell you where the interest rates end, although many people will speculate. Some economists have predicted that the base rate will rise from 1% now to 3% next year, but most do not predict such a large increase. The money markets currently suggest that the base rate will peak at just over 2% in about two years. Interest rates on mortgages are likely to be higher.
If your son already has an approved mortgage, then his budget should have been carefully examined by the lender and he should be well padded against interest rate increases. Before banks and building societies accept a mortgage, they stress test applicants, typically at an interest rate above the regular variable rate. They also look at income and payouts when assessing whether a mortgage is affordable. He will probably also have chosen a fixed-rate mortgage to secure against short-term increases.
If he is applying, rising interest rates will affect what he is allowed to borrow.
Q Is it worth saving these days?
HAY: this is a good question as all the money in a savings account actually decreases in value. With inflation so high, the money you have saved will buy you less than this time last year because there are no accounts that have paid you enough interest to keep up.
But as Sarah Coles of investment firm Hargreaves Lansdown points out, there is good reason to keep savings. “The last few years have shown us how unpredictable life can be and how much of a difference it can make to have something to fall back on when we are hit by the unexpected,” she says. “Everyone of working age should work towards a three to six month savings savings network on an easy access account – which rises to one to three years’ value when you retire.”
This pillow means that if you are hit by an unexpected bill, do not borrow to pay it.
“Right now, all the money in a savings account will lose purchasing power after inflation, but you still have to make sure it works as hard as possible for you,” she says. She proposes an account with instant access from Al Rayan Bank, which pays 1.31%. For a higher interest rate, she says you can earn 2.27% on a one-year solution with Al Rayan Bank or 2.75% on a two-year solution at Market Harborough Building Society.
Q Inflation is 9% for the average person but how do I know what the impact is on me since I might have a bigger mortgage than someone else, or buy other things?
HAY: your personal inflation rate will depend on what you spend your money on – and how much goes on each item. Everyone buys energy, but some people buy more of it, and some people have to spend proportionately more of their income to pay for it. There are calculators where you can calculate your personal inflation rate. ONS has one on its website that lets you fill in exact numbers, just like the investment company Rathbones. These will help you see where your money is going and will be useful for financial planning.
Sp. Is there another way the Bank of England can fight inflation, other than raising the base rate?
SCYTHE: there is a limit to what the bank can do, given the tools at its disposal. Basically, it can make borrowing costs more expensive by raising interest rates, or it can suck money out of the economy through a process known as quantitative easing, which involves selling the bonds it has accumulated since the financial crisis in the late 2000s. . However, principles and QT are blunt instruments. It is the Chancellor, Rishi Sunak, who the country should look to for action.