The new Chief Economist at the Bank of England has warned that inflation may last longer than expected, according to a report by the Financial Times.
Huw Pill, Andy Haldane’s successor, said in a letter to MPs on the Commons Treasury Committee that although inflationary pressures due to Covid and Brexit will subside over time, the ‘’magnitude and duration’’ of this bout of inflation is ‘’proving greater than expected’’.
Pill mentioned that this spike in inflation could persist into next year; ‘’the current strength of inflation looks set to prove more long lasting than originally anticipated.”
The comment comes as inflation, measured by the Consumer Prices’ Index, reached 3.2% in August, above the central bank’s mandate of 2%. Threadneedle Street predicts that inflation may reach or even exceed 4% by December of this year.
Much of the rise in UK inflation has been caused by rising costs of imported goods (due to shortages and supply bottlenecks). The ONS carried out a survey of over 8000 firms and found that 29% of surveyed firms reported a significant rise in input prices over the last two weeks.
Another notable cause of inflation is rising international commodity prices. As demand for oil and gas has risen across the globe (as countries are easing lockdown restrictions and economies are opening up again), supply has become relatively more scarce, placing upwards pressure on prices. This is a further burden on firms as their costs (e.g of running machinery, heating) rise and is likely to be passed on to consumers through higher prices.
Rising inflation is harmful for households as higher prices mean that their costs of living rise, provided that their incomes do not rise in-line with inflation. People on fixed incomes, those without savings or those on low incomes are likely to suffer the most and, combined with a sudden £20 cut in Universal Credit, many may be pushed into relative poverty.
Individuals working for the NHS are being given a pay rise of 3% and workers in some industries, including lorry drivers, have seen recent rises in wages in an effort to attract workers into the industry. These individuals are unlikely to feel the effects of higher inflation as their real wages (taking into account inflation) remain stagnant.
Inflation prospects are likely to impact decisions made by the central bank too. As their principle target is to achieve inflation of 2% they are likely to feel pressure to implement contractionary monetary policy, raising interest rates and potentially tapering their purchases of assets (a process known as Quantitative Easing).
Traders are betting on interest rates rising from the current level of 0.1% to 0.75% by the end of 2022. The Bank’s Michael Saunders (a member of the rate-setting MPC) said, in an interview with the Telegraph, that investors were right to bet on a rise in borrowing costs.
The announcement comes just one month after the MPC voted unanimously to maintain interest rates at 0.1%.
With inflation rising rapidly, real interest rates are essentially negative. This, in theory, could encourage individuals and firms to convert their deposits into liquid assets or take out loans for spending, providing stimulus for an economy which is, arguably, already overheating.
In light of this, it is highly likely that interest rates will be increased to avoid worsening an impending cost of living crisis.
Written by Deandra Peiris
Research compiled by Flora Molali