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  1. The Explainer
18 November 2021

Inflation is at a ten-year high – what does this mean for you?

Where are price rises steepest, what’s causing them, and how long will they last?

By Emma Haslett

The Office for National Statistics (ONS) announced this morning (17 November) that the Consumer Price Index (CPI), the UK’s main measure of inflation, increased from 3.1 per cent last month to 4.2 per cent in the 12 months to October, its highest level in almost a decade.

What is inflation?

Inflation describes how much the cost of living is increasing (if it’s decreasing, it’s known as deflation). In the UK, the main measure of inflation is the CPI. The ONS tracks the cost of living through the prices of items in a hypothetical “basket of goods” that includes everyday products and services. The most recent basket of goods included staples such as a large wholemeal loaf, a roasting joint, olive oil and ice cream, but also added new items, such as hand sanitiser and smartwatches. Ground coffee, Axminster carpets and a 9-carat gold chain were removed.

Why is inflation so high?

The ONS said the main reason inflation rose so fast in the year to October was “increased energy bills due to the price cap hike, a rise in the cost of second-hand cars and fuel as well as higher prices in restaurants and hotels”.

These can all be put down to demand outweighing supply – shortages that develop either because there isn’t enough of something, or because everyone wants it. Energy prices have rocketed recently (and several suppliers have gone out of business) because of constraints in gas supply, and second-hand cars have gone up in price because the global shortage of semiconductors has slowed production of new cars. Meanwhile, restaurants and hotels are having to charge customers more so they can pay their staff higher wages, because many of the people who traditionally worked for them have either moved into different jobs or left the country since the pandemic.

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Is the price of everything going up?

Not everything. Alcohol and tobacco had a “small downward effect” on prices (lest we forget Rishi Sunak’s reform of alcohol duty in the Budget, although that probably came too late to have an effect on these inflation figures). Meanwhile, the price of insurance, including home and car insurance, dropped by 1 per cent over the 12-month period, while books fell by 1.1 per cent and the price of cameras dropped 5.2 per cent. And sugar addicts can take comfort in the fact that items in the sugar, jam, syrups, chocolate and confectionery category fell too – albeit by just 0.2 per cent.

What does high inflation mean for interest rates?

Interest rates and inflation are often mentioned in the same breath because interest rates are one of the ways central banks (the Bank of England in the UK) can try to limit price rises. The Bank of England’s target is to keep inflation around 2 per cent: any higher, and the cost of living becomes very expensive; any lower and prices (and wages) stagnate.

Traditionally, central banks increase interest rates when inflation is high. That means borrowing becomes more expensive, and people and businesses are rewarded for saving, so spending falls, reducing demand and causing prices to drop.

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The Bank of England expects inflation to keep rising to about 5 per cent by April, so expect it to increase interest rates in the coming months.

Will high inflation cause house prices to fall?

Inflation is essentially the measure of how much of something a currency can buy. In the short term, rising prices of materials such as timber may mean that the price of new builds rise slightly.

But UK house prices have been enjoying an uninterrupted rally since a dip just after the sub-prime mortgage crisis in 2008. That’s because the government has used a range of methods to provide cheap debt (or even free debt, in the case of the Help to Buy scheme), ensuring the housing market has been kept more or less constantly buoyant.

The one thing that could interrupt this would be an interest rate hike by the Bank of England, which would push up mortgage rates. But even if the Bank does hike interest rates, it would have to be a significant rise: at the moment, the base rate is at an all-time low of 0.1 per cent, compared with 0.75 per cent before the pandemic. Even a five-fold rise in rates could be withstood by most borrowers.

Is this spike in inflation transitory?

The Bank of England has previously insisted that post-pandemic inflation is “transitory” – a temporary rise in prices brought on by the supply chain constraints created by lockdowns and staff shortages. That argument is being used by central bankers on both sides of the Atlantic.

Some economists don’t agree: although the Bank expects inflation to peak at 5 per cent in April, the supply chain constraints created by the pandemic are likely to continue for much longer. The rise in car prices, for instance, is likely to carry on for a while – the chief executive of Daimler has said the chip shortage could last well into 2023, meaning the price of second-hand cars will continue to stay high. And just yesterday (16 November), gas prices soared by 17 per cent in a day.

But at a session of the Treasury Select Committee on 15 November, Bank of England governor Andrew Bailey insisted it was short-term inflation: “We have had a period of goods-intensive demand, because some important parts of the service sector have effectively been closed down. That rebalancing is happening, but not as rapidly as we probably thought it would. That of course is putting strain on the supply chain system,” he said.

So do I need to start hoarding Christmas presents before their prices increase?

Inflation is going to keep rising until April, the Bank of England says – so prices will keep going up. But panic-buying will only increase demand while supply stays the same, causing prices to rise even faster, so for now, keep your pre-Christmas hoarding to a minimum – or, dare we say it, buy less.

[See also: Gary Stevenson: “I knew the markets were wrong”]

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