January 2021 was only two years ago, but in some ways it seems much further away.
The Covid-19 pandemic was very much still centre-stage — Boris Johnson, British Prime Minister at the time, announced a third lockdown, as the first vaccines were beginning to be distributed.
An angry mob stormed the US Capitol and later in the month, Joe Biden was sworn in as the 46th president of the US.
And UK inflation was 0.7 per cent. A year later, in January 2022, it was 5.5 per cent.
Its upward march didn't stop there — by December 2022, it had risen to 10.5 per cent, having hit a 41-year high in October of 11.1 per cent.
Most economists say the main cause has been increasing energy prices, which began a steady rise in mid-2021 and then shot up after Russia's invasion of Ukraine a year ago.
As inflation advanced, it eroded pay packets and savings, to the extent that any celebration of the 6.7 per cent rise in average pay in the final quarter of last year (from official figures released on Tuesday), quickly fizzled out as it became apparent that inflation meant that rise was really a 2.5 per cent fall in wages.
Earlier this month, figures from the British Retail Consortium showed that prices in shops in January were 8 per cent higher than a year before, the biggest annual increase since at least 2006 when comparable records began.
Especially worrying in the BRC's numbers was the 15.7 per cent increase in the cost of fresh produce, which reflected the high wholesale prices for fruit and vegetables and increased processing costs.
Overall food prices, which include goods with a longer shelf life, rose by 13.8 per cent while non-food prices were 5.1 per cent higher.
Analysts are expecting a slight easing of the inflation rate when the figures for January are released by the Office for National Statistics on Wednesday, continuing the trend downwards from the 11.1 per cent peak reported in October last year.
But at 10.5 per cent, inflation is still way above the Bank of England's 2 per cent target.
Rising inflation, rising interest rates
The Bank of England's rate-setting Monetary Policy Committee has been steadily increasing interest rates to combat inflation.
In early February, base rates increased for the 10th consecutive time to 4 per cent and are expected to peak within the next month or two at 4.5 per cent.
“[Bank of England] Governor Andrew Bailey and the MPC must still navigate between not tightening too much, whereby the economy could tip into recession, and loosening too quickly, which could permit a second round of inflation [and force an even tougher round of new rate rises], as happened in the late 1970s and early 1980s,” said Russ Mould, investment director at AJ Bell.
“Remember that the Bank of England’s sole mandate is to keep inflation at or around the 2 per cent level.”
Rising inflation and interest rates presents a double-whammy for UK households. Simultaneously, real wages are falling and household budgets are faced with both higher prices and mortgage payments.
But Mr Andrew Bailey is convinced that inflation has “turned the corner” and will fall back significantly in the second half of this year.
There are few reasons for this. The Bank of England says a fall in energy prices is expected to be the main driver of the drop in overall inflation.
Energy prices, especially wholesale gas prices, have halved in Europe over the past three months. However, how long that takes to feed through to household energy bills is more uncertain.
Secondly, the central bank expects the prices of imported goods to fall as “some of the production difficulties businesses have faced are starting to ease”.
Also, the effect of 10 — or more, possibly, from next month — rises in interest rates will start to take demand out of the UK economy. Once people are spending less, prices fall, in theory at least.
“In the UK, record wage growth raised concerns the UK's inflation problems might prove stickier than feared ahead of the UK posting its own CPI numbers on Wednesday,” said Russ Mould at AJ Bell.
“However, the Bank of England will likely be hoping the lagged impact of a series of rate increases is yet to fully come through amid growing expectations a rate hike in March will be the last.”
The Bank of England has difficult balancing act, and it is all about timing.
Basically, inflation has the ability to rise rapidly. Interest rates have the ability to reduce inflation — by reducing demand — but also have the ability to stamp on demand too much, thus crimping economic growth.
Rates 'too high right now'
Silvana Tenreyro, one of the members of the Bank of England's MPC, feels enough has been done to tame inflation and that the Bank of England now needs to sit back and watch its rate rises take effect.
She told MPs last week that inflation was “pretty much guaranteed” to fall this year, unless there was a new global shock, and that, at 4 per cent, interest rates were “too high right now”.
But for her colleague on the MPC, Catherine Mann, there are still considerable upside risks to inflation in the UK — risks that can only be alleviated by higher interest rates.
“We need to stay the course and, in my view, the next step in bank rate is still more likely to be another hike than a cut or hold,” she said in a speech last week.
Mr Bailey has opted for the middle ground, a wait-and-see stance combined with a preparedness to act should inflation rear its head later in the year.
“[Inflation] has not only fallen, it is now under what we thought it would be in the November report. But we need to see more evidence that this process will take effect,” he said.
