Why is the cost of living going up?

 

 Inflation is at its highest rate for 10 years, having risen to 5.1% in the 12 months to November.

The jump in the cost of living, driven largely by rising fuel and energy costs, puts further pressure on households across the UK.

How will inflation affect me?

Inflation is the rate at which prices are rising. If the price of a bottle of milk is £1 and it rises by 5p, then milk inflation is 5%.

You may not notice price rises from month to month. But right now, prices are rising so quickly that average pay is not keeping up.

It means that the money people earn does not go as far.

In the year to November 2021, regular pay, excluding bonuses and adjusted for inflation, fell 1%.

There are workers in a few sectors - such as lorry drivers - who are in high demand, and whose wages are faster than prices many business listings.

And in April, the lowest-paid will see the National Living Wage rise by 6.6% to £9.50 an hour - which is higher than the current inflation rate.

But many people are seeing a noticeable drop in their "real" wages.

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Why are prices rising now?

The main reason is the rising global price of energy. This has meant higher energy and transport bills for businesses, many of whom pass on the extra costs to customers.

Supply problems and higher shipping costs also continue to hurt businesses.

Next, the High Street retailer has admitted its prices could rise by up to 6% this year to keep up with higher costs.

Staff shortages are a particular problem in the UK, due to Brexit and the pandemic, and are prompting some employers to raise wages.

However, this can itself contribute to inflation. Greggs, for instance, has raised the price of some foods in order to cover increased labor costs.

 

What else could affect the cost of living in 2022?

·         A number of measures will hit UK households:

·         Regulated rail fares in England will rise by 3.8% in March

·         TV and broadband prices are also due to increase at that time

·         In April, companies, workers, and the self-employed will start paying an additional 1.25% in National Insurance contributions under the Health and Social Care Levy

·         The same month is likely to see substantial rises in gas and electricity bills

UK cost of living squeeze in 2022, says think tank

How is inflation measured?

Inflation is measured by a body called the Office for National Statistics (ONS) which notes the prices of hundreds of everyday items business listings.

These items are called the "basket of goods", and they're being constantly updated. For instance, in 2021 hand sanitizer and men's loungewear bottoms were added, but sandwiches bought at work were removed.

The ONS releases its measure of inflation each month, showing how much these prices have risen since the same date last year. This is known as the Consumer Prices Index (CPI).

What can be done to tackle inflation?

The Bank of England's traditional response to rising inflation is to raise interest rates.

That means anyone who has borrowed money could see their monthly payments go up, especially on mortgages tied to the Bank of England's rates.

The idea is that when borrowing is more expensive, people will have less money to spend. As a result, they will buy fewer things, and prices will stabilize in response.

But if inflation is caused by external forces, such as the global squeeze on energy prices, then this might not be the answer.

The government might choose instead to cut taxes for consumers on items that are rising quickly - such as VAT on energy bills.

Or, it might target support for those who need it most. It has been reported that it is considering expanding the Warm Homes discount scheme, for example, which offers those in receipt of certain benefits the option to apply for a one-off £140 payment.

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Rising prices and flat productivity are two of the challenges facing the government

The UK is facing two supply shocks right now.

One is a global supply shock as the world's economy sluggishly wakes up from lockdown.

It shows itself in backed-up cargo ships from China in California's seas, unable to offload their cargo; in thousands of cars left without microchips; in rising natural gas prices free business listings.

On top of that, there is a UK-specific supply shock.

Inflation pressures

This comes from fewer European workers and the imposition of non-tariff barriers on trade with the rest of Europe.

Both these shocks are pushing up general prices. The global shock is the dominant factor right now, but in some sectors such as pig farming, and into the future, the UK-specific supply crunch may matter more.

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The PM has sewn together several acute economic phenomena and sought to explain them in one sweeping narrative: that a constrained supply of foreign workers will help raise wages for Britons.

Driver shortages that were only a month ago denied as having any relation to post-Brexit policy are now embraced as the very point of EU exit.

Indeed, the shortages at petrol stations and on some shop shelves are seen as being part of a transition to a new post-Brexit high-tech and high-wage economy.

·         Conservative conference: the UK in a period of adjustment after Brexit, says PM

The Prime Minister is right to argue that these are problems we may have wished for given the situation a year ago.

They are problems of surging demand and normalization of demand in the economy.

That was far from certain a year ago, amid fears of lockdowns causing depression and mass unemployment.

But while we have reported on rising wages in sectors where there are shortages, this is yet to filter into the overall figures for earnings in the economy.

Wage rises

Some annual earnings figures are up by extraordinary amounts, but that is the consequence of distortions in the statistics from lockdown and furlough.

The same distortions led to the suspension of the triple lock for pensions.

Up to a point, it is good news for those with skills in hot demand.

But the wage rises are not the result of increases in productivity. They are the consequence of those two significant supply shocks.

There are fewer workers as a result of a combination of Covid and Brexit.

And there are severe post-pandemic logistical crises and backlogs affecting the world, most clearly the microchip shortage in the car industry.

Costs are going up for the same amount of production.

The trade-off between economic growth and inflation is getting worse.

In simple terms, if this is right, the wage rises seen in certain occupations will be gobbled up by rising prices across the economy.

Robots

The answer, says the government, is for businesses to invest in the workforce with training and skills to raise productivity to match wage rises.

A ready pool of workers from the EU, up until this year, decreased the incentive for such investment.

The Chancellor's "super deduction" tax cut provides an additional huge incentive for businesses to invest in new machinery to improve productivity.

The UK is far behind Japan and other countries in 'robot density'

The UK, for example, does not even appear on league tables of industrial "robot density", having less than a third of the number of robots per 10,000 employees of Germany, Sweden, and Japan, and a tenth of Singapore's number. So there is room for significant improvement.

But that still leaves a considerable timing gap.

Consumer prices are going up now. In a best-case scenario, the productivity enhancement to match them will take years.

But more than that, in many manufacturing industries the super deduction investment is far more likely to involve automation of jobs previously done by EU agency workers, than their replacement by retrained British workers.

Consumer hit

The other challenge for the government is that inflationary pressures cannot really be naturally contained by forcing the private sector to increase wages.

There are numerous examples of bin collectors or bus drivers being sucked into the freight industry, given the wage rises.

But then where are the bus drivers and bin collectors then going to come from?

The local providers of public services will also have to raise their wages, which will hit prices or council tax and business rates.

Can a more general public service pay freeze survive a structural rise in inflation?

Throw in an imminent judgment on the rise in the National Living Wage, and it is difficult to see how consumers don't end up footing a larger bill for these wage rises.

And then there is a very significant concern that Number 10 may well be underplaying.

Rate rise pressure

An independent Bank of England needs to be able to smash incipient inflationary pressure with a great big mallet.

The Bank has been traditionally willing to look through one-off spikes at energy prices, or currency falls, or the impact of the post-pandemic rebound: that is, to avoid interest rate rises at times of high inflation.

But the government is leaning into the post-Brexit supply shock to wages.

It is, in some part, the author of this additional labor supply shock, which makes the economy more inflationary.

If it can make a definitive judgment that this is indeed the case, then the bank will raise interest rates more quickly and possibly by more than otherwise.

Both it and the OBR are currently assessing the impact of these factors.

So there are significant challenges to the government's new economic strategy.

Clearly, it is not just about economics.

The "positive" supply shock from British firms having access to an unlimited pool of east-European workers had social and political consequences, which helped bring about Brexit and the Prime Minister to power.

But the neat narrative that current stresses and strains are all part of a transition plan is risky.

It makes the Bank of England's waiting game more difficult.

And well before the fruits of high investment, technology and wages emerge, it stands to be tested by the immediate reality of rising prices, and perhaps by international markets too.

More on this story

·         PM: the UK in a period of adjustment after Brexit

·         Why is the cost of living going up?

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