The UK's rate of inflation keeps rising, with each monthly update providing more disheartening news. Rising food and energy prices have contributed to the current squeeze on the cost of living, together with the Bank of England increasing interest rates to try to control inflation. May's increase in the consumer prices index (CPI) was modest by recent standards, but even so the rise from 9% to 9.1% was a new 40-year-high.
Unfortunately, this does not look to be the peak, with economists predicting inflation will trend upwards for the remainder of the year as the cost-of-living crisis continues. Here, we look at the causes of inflation and what it means for your money.
What is inflation?
Inflation is the term used to describe the increase in prices over time. The rate of inflation measures how quickly prices of goods and services are rising.
The inflation rate is a way of measuring the decline in the purchasing power of money over time.
The Office for National Statistics (ONS) measures the price of a 'basket' of goods and services every month. The overall price of this 'basket' is compared to the price one year ago, and the rate of inflation is calculated as the percentage change in price.
Inflation hits 40-year high
UK inflation rose to 9.1% in May, according to the latest data from the ONS. The figure is a slight increase on the 9% figure of the previous month, which was driven upwards by April's unprecedented rise in the energy price cap, and is the highest since March 1982.
The ONS said rising prices for food and non-alcoholic drinks, compared with falls a year ago, pushed up the inflation rate.
In response to the figures, Chancellor Rishi Sunak said: 'I know that people are worried about the rising cost of living, which is why we have taken targeted action to help families, getting £1,200 to the eight million most vulnerable households.
'We are using all the tools at our disposal to bring inflation down and combat rising prices – we can build a stronger economy through independent monetary policy, responsible fiscal policy which doesn't add to inflationary pressures, and by boosting our long-term productivity and growth.'
CPI vs PPI
The government's preferred measurement of inflation is the CPI. This uses a basket of everyday goods and services, including food and drink, clothes and transport, utilities and larger items or luxuries, such as a car or a holiday.
However, the Producer Price Index (PPI) is a measure of what is happening at an industry level. This includes the costs paid by companies for their fuel and raw materials, and the costs they are charging to their customers. It is an indicator of price pressures before they reach consumers.
According to the PPI, fuel and raw material prices were up by more than 22% year on year – the fastest rate since modern records began in 1985. The price of goods leaving factories are increasing at an annual rate of 15.7%, up from 14.7% in April.
The PPI suggests upward pressure on the CPI for some months to come. A leap of around 40% in the energy price cap is forecast to come into force in October and the likelihood is that the annual inflation rate will nudge 11% later this year.
How is inflation controlled in the UK?
The Bank of England uses interest rates as a tool to control inflation. Higher interest rates make it more expensive for people to borrow money and makes saving money more attractive. Both of these factors result in people spending less.
In theory, prices are a function of supply and demand – if demand for products and services falls, this should result in prices rising less quickly, remaining the same or even falling.
The Bank of England has increased interest rates on five occasions since December, with the current base rate standing at 1.25%. It is expected to continue to raise interest rates this year to reduce inflation.
Erosion of value
According to the latest Bank of England figures, the average interest rate on new savings accounts is 0.9%. With the current inflation rate of 9.0%, money in savings accounts is losing 7.4% in real terms each year.
Rising inflation will continue to put pressure on both household and business finances this year. If you need advice on improving your cashflow, please contact us.