Inflation hits a record 20-year high

In September 2011, inflation hit a record high of 5.2 % as the Bank of England failed to reach the target of 2%. Despite inflation being at a record high, interest rates are at a record low of 0.5 %, and quantitative easing has recently been increased to £75 bn.  Economists had been expecting the consumer price index (CPI) measure of inflation to rise to 4.9% from the 4.5% recorded in August. The CPI reached 5.2 %, whilst the RPI (Retail Price Index) measure of inflation reached a high of 5.6 %. The consumer price index measures the changes in prices of goods and services that households purchase. In contrast, RPI measures the change in the cost of a basket of retail goods and services.

There are two types of inflation that may occur; cost-push and demand-pull inflation. Cost-push inflation is when inflation increases due to higher prices, and demand-pull is a situation easily described as too much money spent chasing too few goods. The high inflation that the UK is currently experiencing is the cost-push type, which can be mainly attributed to soaring gas and electricity prices. It occurs when firms increase their prices to protect their profit margins in response to higher costs of production. Higher costs of production are a result of rising prices of raw materials, such as crude oil.

Michael Saunderst, Economist at Citi commented: “We suspect that CPI and RPI inflation are around their peaks, and likely to plateau in the next couple of months before falling. At this stage, our forecast is for CPI inflation to edge down to 5.1% year-on-year in October and 5.0% in November, before falling to about 4.3% in December and lower in early 2012 as the VAT hike drops out. We do not currently expect CPI inflation to return to the 2% target in 2012 but, with the economy close to recession and the severe euro area crisis, the UK economy faces much bigger threats than the issue of whether inflation next year is 2-3%.”

Higher inflation will impact upon those who claim benefits or those who have pensions the most, as it means the real value of these will fall exponentially with time. Since people’s real wages are not rising at the same rate that inflation is, this will detrimentally impact on employees as their real incomes fall. People are not able to purchase the same bundle of goods with their current incomes since prices have risen; in essence, their purchasing power has fallen.

Mervyn King, the governor of the Bank of England, has blamed the slow recovery of the UK’s economy on the problems in the Eurozone as well as slow international recovery. In his speech last month, he said: “2011 has been the year of reluctant recovery. Growth has disappointed both here and abroad. Business and consumer confidence have fallen sharply. The level of world trade in goods has stagnated. A slowing of the world economy especially in the Euro area is a threat to our strategy of rebalancing the UK economy.” He also said that the rate of the increase in CPI was as expected by the Monetary Policy Committee (MPC). He is defiant that although inflation is at a record high, it has now reached its peak and will fall over the coming months. This is the view that most economists also take.

The general consensus seems to be that the budget deficit needs to be cut; but the dilemma is how best to deal with it. It is not a question of why, but of how? Recently, one hundred of the UK’s leading economists told George Osborne, Chancellor of the Exchequer, that we must turn to “Plan B” amid fears of a double-dip recession. In an open letter to The Observer, the Economists wrote: “It is now clear that Plan A isn’t working. Wave after wave of economic figures […] and have all concluded the British economy is faltering.” They have outlined a series of proposals entitled “Plan B: a good economy for a good society”. The proposals include an immediate halt of public sector cuts, a new round of quantitative easing to create more jobs, an increase in benefits, and a financial transaction tax to raise funds from the city to create funds for investment in better transport.

We know that the economy needs fixing; but unfortunately, George Osborne isn’t in possession of a magic wand. Perhaps the proposals in Plan B offer some hope towards a recovery.

 

Written by Noorulann Shahid

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