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18 October 2016

Inflation at a 2-year high – how worried should we be?

Why prices are rising. 

By Julia Rampen

Inflation was 1 per cent in September, compared to 0.6 per cent August, according to the Office for National Statistics. It’s the biggest monthly rise in two years.  

What does that actually mean for my wallet? 

The inflation figure is taken from the Consumer Price Index, which is a theoretical shopping basket including e-cigarettes, chilled pizzas, breakfast cereal, tea bags, vegetables, underwear and other everyday items. The price of these items has risen 1 per cent between September 2015 and September 2016.

Because inflation is a measure of the rate of rising prices, inflation was therefore at 1 per cent in September.

Why did prices rise?

Clothing became more expensive, as did overnight hotel stays and petrol. Household energy bills also crept up in September, compared to the previous month. 

The backdrop to this is the fact the oil price, which plummeted in late 2014, has started to edge upwards again. It’s worth remembering that inflation was far higher between 2009 and 2014. 

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Is this about Brexit?

Economists widely believe that the collapse in the value of the pound will lead to higher inflation, because goods imported from abroad will become more expensive. 

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There are already individual examples of this – the Liberal Democrats reported a 75 per cent increase in the price of butter was forcing one shortbread maker to put up prices. 

The ONS said it was important to take seasonal trends into account, but it added that “the depreciation in sterling is likely to increase the cost of importing goods and outsourcing production”. 

One reason we’re not seeing more impact now may be due to the fact, as the ONS noted, that many businesses have taken short-term measures to protect against exchange rate changes. 

What happens next?

Since 1992, the Bank of England has used inflation targets. The basic principle is that those in charge of monetary policy should prioritise stable prices above almost everything else. 

In theory, the Bank can control inflation by raising interest rates. But since 2009, the Bank has instead pursued a policy of keeping interest rates very low. This provided relief for mortgage borrowers, and helped stimulate the economy. In the aftermath of Brexit, the Bank cut interest rates even further, to 0.25 per cent.

The Bank of England’s chief, Mark Carney, said last week that inflation would rise, and food prices are likely to be affected first. 

But he said he was “willing to tolerate a bit of an overshoot in inflation” in order to avoid higher unemployment and other economic shocks. 

In short, if you’re a middle-class worker in a well-paid job, and your biggest expense is your mortgage, the Bank’s policies will shelter you from the worst of the post-Brexit economic shock. 

On the other hand, if you’re already struggling to get by on low wages, or frozen benefits, and covering the week’s food bills is a frightening prospect, things are going to get worse.