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What rising prices mean for us all

According to energy expert Mike McWilliams at the Centre for Economics and Business Research, the price of fuel at petrol stations will fall later this year but the cost of heating our homes will stay high for years rather than months.

Rising energy costs are one of the main factors pushing inflation towards the 8 to 10 per cent mark, and the reason why rate rises will remain ineffective in bringing it back down to a desired target of around 2 per cent. They aren’t the right medicine for these external forces. Rate hikes can of course do some good by suppressing price rises elsewhere, but tightening has to be done carefully given the potential to tip us into a recession. 

While those rate hikes are slowly dripped onto the market, inflation could yield wins for some parties – shrinking the value of debt and increasing the government’s tax take due to frozen thresholds. And we might all reduce our usage of polluting fuels. 

But mostly, inflation is damaging. It erodes our purchasing power, devalues our savings, lands us with extortionate energy bills and can lead to weaker returns from our investments as companies bear the brunt, too. Inflation and a tightening cycle add to uncertainty about the future and depress economic activity as businesses become nervous about investing and about consumer spending. And even if inflation has largely been under control for years – Credit Suisse’s 2022 study of global investment returns shows that between 2014 and 2019, out of 21 major countries, 17 had inflation rates below 2 per cent – no one can afford to disregard the threat it poses. The conequences of an inflationary spiral are too great for that.

In the UK, house price inflation has been running rampant too. Between the start of the pandemic and February this year, the average house price in the UK rose by 20 per cent, according to Nationwide Building Society figures. And affordability has become more stretched, as price growth outstrips earnings growth. The price of a typical home is now equivalent to 6.7 times average earnings, up from 5.8 in 2019.

There really isn’t any mystery around the skyrocketing prices. They have been brought on by low interest rates, Help to Buy, pandemic savings, stamp duty holidays, first-time buyers anxious to jump on board before prices move further out of reach and a desire to stop throwing money away on rising rents. Supply issues are a factor too. 

At least, thanks to low interest rates, almost all mortgages taken out in recent years have been on fixed-rate deals, which means the current base rate hikes won’t have a major impact. Yet. High house prices mean high debt. 

What might help cool things down is the combined effect of the cost-of-living crisis alongside higher taxes and interest rates creeping up. Yet given the dynamics of supply and demand, what’s more likely in the absence of a recession and job losses, is a slowing in the rate of house price growth rather than a steep fall. But any concern that housing wealth may be weakening can cause homeowners to start economising.

Inflation’s effect on stock markets is also worth noting. Paul Marsh, Elroy Dimson and Mike Staunton at Credit Suisse have found that in deflationary times, equities deliver much higher gains compared with inflationary times – but they still outperform bonds (and cash savings) significantly during the latter.

Tightening cycles also have an impact. The researchers found that in the UK, equities delivered an annualised real return of 1.2 per cent during rate-rise periods compared with 8.5 per cent during easing cycles. They also found that in tightening cycles there was relative outperformance from defensive versus cyclical stocks and from large versus small-caps. But they warn that the findings are based on long-term averages spanning many different economic conditions, which conceal considerable differences between cycles – encouragingly during 40 per cent of US hiking cycles equities performed better than during the easing cycles that preceded them.


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