Until this year, UK inflation had largely dropped off the list of financial things to worry about. For most of the past seven years the consumer price index (CPI) used as the headline measure for inflation was below the Bank of England’s 2 per cent target introduced in 2003, and concerns focused more on the spectre of deflation than on any risk of rapidly rising prices. Even looking back almost three decades, to 1992, inflation has spiked above 4 per cent only twice, in 2008 and 2011.
So why, with the latest (September 2021) data from the Office for National Statistics showing CPI at just 2.9 per cent, down from 3.0 per cent in August, is there such a kerfuffle about inflation? And what comparisons can we draw with the inflationary crises of history?
The Covid pandemic has caused huge disruption to growth for economies worldwide; the UK’s recovery – already hampered by supply bottlenecks and increasing energy prices – has been made more difficult by widespread foreign labour shortages as a result of Brexit.
In the short term, according to the Institute of Fiscal Studies (IFS), CPI is forecast to peak at 4.6 per cent in April next year, driven by rising energy costs, trade disruptions and a handful of mainly imported goods. “For now, the drivers here seem transitory,” says the IFS. “However, inflation expectations are more of a concern. If these begin to shift up, firms may be willing to accept higher wages and offer higher prices – creating the potential for a genuine wage price spiral.”
That is feeding into wider concerns about rising costs. The Institute of Directors (IoD) Economic Confidence Index, which measures the net positive level of optimism in the UK economy among directors, recorded a value of -1 per cent in September 2021, down from 22 per cent in July. It was last this low back in February, in the depths of lockdown.
Three-quarters of IoD members anticipate costs rising in the next 12 months. “A higher proportion of our members expect costs to rise in the next year than expect revenues to rise,” says Kitty Ussher, chief economist at the IoD. “This is not helped by the government’s recent decision to raise employers’ national insurance contributions, which acts as a disincentive to hire just when the furlough scheme is ending.”
Consumer surveys also show widespread concern about the outlook. A survey carried out in mid-October by broker interactive investor found that the biggest perceived threat to financial security was rising prices, cited by 47 per cent of respondents.
It’s useful, however, to get some long-term perspective on the situation. Inflation is certainly nothing new: for example, 14th-century China’s move from coinage to paper money caused prices to rise, as did the influx of gold and silver from the New World into Europe and the rest of the world in the 16th century.
However, the 20th century has seen the worst bouts of inflation in history, sparked in many cases by seismic upheavals – world wars, decolonisation and the fall of communism.
Germany’s Weimar Republic suffered hyperinflation in the aftermath of the First World War; the debt-laden government responded by printing more money to pay striking workers in the Ruhr. By October 1923, prices were rising by 29,500 per cent a month: a loaf of bread, which cost 250 marks in January 1923, had risen to 200,000 million marks by November.
Hyperinflation also decimated countries devastated by the Second World War: in Hungary in July 1946, inflation reached 41.9 quadrillion per cent and prices were doubling every 15 hours.
Brazil had persistently high inflation for decades from the 1960s onwards and particularly during the 1980s, averaging over 700 per cent a year between 1985 and 1989. An article in the Journal of Latin American Studies pinpoints the cause as excessive monetary growth, oil price and exchange rate shocks, and lack of central bank independence.
In comparison, the UK’s inflationary experience seems pretty tame. It experienced its worst inflation since the First World War in the early 1970s, when prices climbed dramatically, with CPI reaching almost 23 per cent a year in 1975.
The rises were driven by the 1973 OPEC oil crisis, which led to a 300 per cent increase in fuel prices. At the same time, union power was forcing wage increases to keep pace with the rising cost of living, resulting in the kind of wage-inflation spiral concerning economic commentators today – not to mention power cuts and a three-day working week as the miners’ strike crippled the country.
So could we go back to the dark days of 1970s-style stagflation – high inflation alongside low growth and widespread unemployment?
We’re a long way from those days, with inflation still very much in single digits, and as the IFS says the drivers may prove transitory. However, commentators are keeping a worried eye on persistent labour pressures as a result of Brexit, as well as regulatory barriers to trade that are likely to inhibit growth, and fallout from the end of the furlough scheme, which could push up unemployment.
Moreover, it’s not easy to resolve. As Jim Leaviss, M&G Investments’ head of public fixed income, pointed out to the Financial Times, stagflation would leave the central banks “in a bind”: they can raise interest rates to dampen demand, but it won’t resolve supply chain problems or “bring back lorry drivers”.
Let’s hope we can sidestep that unwelcome twist to historical precedent.
