Inflation in the UK fell to the Bank of England’s 2 per cent target on Wednesday, June 19.
The UK economy has been a major focus point for the Conservatives and Labour before the July 4 general election.
According to the latest data, headline inflation in the UK is lower than rates in the US and the Eurozone.
The Bank of England will announce its latest interest rates on Thursday, June 20.
But what is inflation and what does it mean for wages and mortgages?
Inflation refers to a general increase in the prices of goods and services in an economy over time.
Various factors can drive up prices or inflation in an economy. Typically, inflation results from production cost increases or rising demand for products and services.
For example, if a bottle of milk costs £1 and that rises by 5p compared with a year earlier, then milk inflation is 5 per cent..
Inflation is primarily caused by two main factors: demand-pull and cost-push pressures.
Demand-pull inflation occurs when consumer demand exceeds the available supply of goods and services. This can be driven by factors such as increased consumer spending, fiscal policies that boost government expenditures or cut taxes, and monetary policies that lower interest rates, making borrowing cheaper.
When demand outpaces supply, businesses raise prices to capitalise on the heightened demand, leading to inflation.
The Bank of England last achieved its 2% inflation objective in July 2021
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On the other hand, cost-push inflation arises from increased production costs that businesses pass on to consumers. Factors contributing to cost-push inflation include rising costs of raw materials, labour, and energy — and supply chain disruptions and geopolitical events. When businesses face higher costs, they often raise prices to maintain profit margins, thereby pushing up the overall level of prices in the economy.
Additionally, built-in inflation, driven by expectations of future price increases, and monetary factors such as money supply and interest rate changes also play significant roles in shaping inflationary trends.
External factors including global commodity prices and exchange rate fluctuations can further influence inflation by affecting production costs and the cost of imported goods. Governments and central banks employ monetary and fiscal policies to manage inflation, aiming to maintain stable prices while fostering economic growth.
How is inflation calculated?
In the UK, inflation is primarily measured using the Consumer Price Index (CPI), which tracks the average change over time in the prices consumers pay for a basket of goods and services. The Office for National Statistics (ONS) compiles and publishes the CPI monthly.
The calculation involves selecting a representative sample of goods and services commonly purchased by households, including categories such as food, housing, transport, clothing, and recreation.
To calculate CPI inflation, the ONS collects price data for these items from thousands of retail outlets across the UK. Prices are weighted according to their relative importance in the average household’s spending. Each month, the ONS compares the current prices of the items in the basket to their prices in a base period, typically set to a specific year (currently 2015 in the UK).
The Consumer Price Index (CPI) is adjusted periodically to reflect changes in consumer behaviour and spending patterns
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The percentage change in the CPI from the base period to the current one gives the inflation rate.
The CPI is adjusted periodically to reflect changes in consumer behaviour and spending patterns. It includes various versions such as CPIH (including owner-occupiers’ housing costs) and RPI (Retail Price Index), although CPI is generally preferred for official purposes.
The Bank of England uses CPI inflation as a key indicator in its monetary policy decisions, aiming to keep inflation close to a target set by the Government, typically around 2 per cent per year.
How can inflation be harmful to a country?
Inflation can become a destructive force in an economy if it is allowed to get out of hand and rise dramatically.
Unchecked inflation can topple a country’s economy, as it did in 2018 when Venezuela’s inflation rate hit more than 1,000,000 per cent a month. This caused the economy to collapse and forced countless citizens to flee the country.
In the 2000s, Zimbabwe experienced hyperinflation, with inflation rates soaring to several thousand percent per year. This hyperinflation devastated the economy, eroded savings, caused severe shortages of goods and services, and led to social and political unrest.
What does inflation mean for mortgages?
Rising inflation will have an impact on homeowners but how much depends on the terms of their mortgage.
The Bank of England may increase interest rates to try to slow inflation when it rises.
As a result, when interest rates rise, mortgages can become more expensive, although this will depend on their type.
People with tracker mortgages, which track a base rate (usually the Bank of England’s), will see their interest rates rise a month after the Bank of England increases the base rate.
Meanwhile, people on fixed-rate mortgages won’t be affected immediately. These mortgages fix the interest rate a homeowner pays for a certain time — usually two years or five years.
Once a tracker or fixed mortgage ends, lenders can put borrowers on a standard variable rate mortgage. This means mortgage payments could change each month, depending on the rate.
What does inflation mean for wages?
Inflation erodes the purchasing power of wages over time because rising prices reduce what each unit of currency can buy.
Without corresponding wage increases, inflation can effectively decrease real wages, impacting the standard of living for workers.
Content Source: www.standard.co.uk