The rate of inflation has risen again in the last month, from 2.1% to 2.5% – the highest it has been for nearly three years. Some experts are say that this rise could be a warning sign that the economy is running into trouble, while others say its just because the economy is starting to grow again. But why is inflation so important?
What is inflation?
Simply put, inflation is the rate at which prices are rising – if the cost of a £1 jar of jam rises by 5p, then jam inflation is 5%. It applies to services too, like having your nails done or getting your car valeted. You may not notice low levels of inflation from month to month, but in the long term, these price rises can have a big impact on how much you can buy with your money.
How is it measured?
The Office for National Statistics (ONS) keeps an eye on the prices of thousands of everyday items, from cinema tickets to smart-speakers. This is what’s known as the “basket of goods”, and it’s being constantly updated. For instance, this year the ONS added hand sanitiser, smart watches and exercise equipment, after lockdown changed many people’s spending habits. More weight is given to things we spend more money on – if the price of petrol rises by 1p, that will have a bigger impact on the headline inflation rate than, say, 1p on a book of second-class stamps. The ONS releases its measure of inflation each month – showing how much these prices have risen since the same date last year – known as the Consumer Prices Index or CPI.
What is the inflation rate used for?
The inflation rate is used to inform a whole range of decisions, from how much pensions will rise to the price of train fares. It’s keenly watched by economists too. They see inflation as a sign of what’s going on in the economy. A bit of inflation is considered helpful: it encourages people to keep spending, if they expect prices to rise in a few months time. And that’s good for business. So the Bank of England aims to keep inflation at around 2%. But if prices are rising too sharply, it’s seen as a sign that the economy is running into difficulties, with demand outstripping supply. This is why, if inflation rises quickly, the Bank of England will often tackle it by raising interest rates. If interest rates rise, then the cost of mortgages, student loans, and other borrowing, go up. This means that people and businesses will have less money to spend, demand will fall, and prices will stop rising so quickly.
So is inflation really on the rise?
Before the pandemic hit, UK inflation was around 2% – the rate the Bank of England aims for. However, as with everything else, Covid has played havoc with headline inflation figures.
For most of the last year prices have been rising at a rate of less than 1% a year. But in June it rose to 2.5%. It’s not clear whether this rise is part of a new trend, because these aren’t exactly normal times. Over the past year we haven’t had much chance to buy nightclub cocktails, go on package holidays, or even pay for as many train tickets to work. Instead we spent a lot more on groceries and streaming subscriptions. But the ONS’s basket of goods didn’t reflect these changes until recently.
So last year’s low inflation may have been off the mark, and this year’s higher inflation could just be a correction. It will take several months more before we can really tell.
Should we be worried?
Looming inflation can strike fear into people’s hearts. There are terrifying stories of hyperinflation. In 1920s Germany people burned banknotes to keep warm. And in 2008, inflation in Zimbabwe hit 80 billion percent. In the UK, inflation rates have barely been above 4% for nearly a decade, so this month’s rise is not in the same league. But there is fierce debate among economists over whether higher inflation is in the pipeline. Some say years of low inflation have made us complacent. They warn that the government’s measures to combat Coronavirus, the huge amounts of borrowing and spending that have been needed just to stop the economy collapsing around our ears, could lead to dangerous levels of inflation. Others say there isn’t really any underlying cause for concern. Inflation was low before the pandemic and they don’t believe that will fundamentally change once life returns a bit more to normal.
Source: BBC News.