While inflation is expected to ease back towards the Bank’s 2% target in a few years, policymakers said they were prepared to raise rates again “dynamically” if there were signs that price rises and wage rises were consolidating. A survey by the Bank of UK businesses found that families were already trading in cheaper brands in their weekly supermarket shop. They were also more likely to repair rather than replace broken items and postpone trips to the dentist. Nadhim Zahawi, the chancellor, and Mr Bailey issued a joint statement on Thursday night, pledging to “work to reduce inflation and the impact of rising prices on households”. Mr Zahawi was criticized along with Prime Minister Boris Johnson for a holiday while the Bank published its dire financial outlook. Mr Zahawi said he was “working remotely” on a family holiday. The chancellor said: “There is no such thing as a holiday and not working. I never had it in the private sector, nor in government. Ask any businessman and they’ll tell you that.”
The four main drivers of the cost of living crisis
By Tim Wallace Speaking on Thursday, Andrew Bailey, the Governor of the Bank, laid much of the blame for the rise in prices at the door of the Kremlin. “The Russian shock is now the biggest factor in UK inflation by some way,” he said. But it is not the only factor. Here are the four main drivers of the cost of living crisis:
Energy prices
Household energy bills were rising rapidly before the invasion, but Russia’s decision to attack Ukraine sent prices into overdrive. In recent months, Moscow’s threats to cut off gas supplies from Europe have increased the pressure even more. Mr Bailey said prices for gas delivery at the end of this year are seven times higher than market forecasts last year “overwhelmingly as a result of the curtailment of gas supplies from Russia to Europe and the risk of further curtailments”. The result is a huge increase in the energy price cap in October. The Bank expects a 75% jump. “This would increase the typical annual dual fuel bill from just under £2,000 to around £3,500 in October,” the minutes of the MPC report said. Ben Broadbent, Mr Bailey’s deputy, compared the situation to the energy price shocks of the 1970s. The impact on household budgets will be five times greater than that shock five decades ago. “During the worst two years of the 1970s, between the first quarters of 1974 and 1976, the share of income derived from household utility bills rose by 0.7 percentage points, so it absorbed so much of the increase in real income during this period. he said. “Between the first quarter of 2021 and 2023, we think that number will be almost 3.5 percentage points, it’s about fivefold.”
Food prices
Food costs have also increased as a result of the war, as Russia and Ukraine are both major grain producers. “The food situation has been very serious and remains very serious,” Mr Bailey said, noting that the jump in the cost of staples is particularly damaging to low-income families. There may be some reason to hope that the increases in these prices may slow down soon, unlike energy. “The prices of basic food products have declined in recent months,” the Governor said. “It reflects the fact that there has been quite good news on crop yields elsewhere in the world. We all hope that the ship that left Odessa this week will be the first of many and provide the relief we needed.”
Supply chains
Inflation was a problem before the Ukraine war, and much of the pre-Ukraine price increases stemmed from chaos in global supply chains. Covid has shut down factories, ports and shipping routes and spiked demand for physical goods as locked-down families have had no chance to spend their money to go out and seek entertainment. Some of it continues. China’s regular lockdowns persist because of the world’s second-largest economy’s ongoing “zero-coronavirus” strategy. This disrupts production in factories there. The Bank of England said there were “some early signs that supply bottlenecks were beginning to ease” but that “constraints remained elevated”. “Some indicators of shipping costs were down from their peaks, while PMI surveys showed that manufacturing lead times were down in different regions.” Mr Bailey said the “series of supply shocks” from Covid and the war had a cumulative impact: the global economy was struggling to recover from one before the other hit. “There were no air gaps between these shocks. If you think about the supply chain shock of the coronavirus, which we’re now starting to see signs of in terms of commodity prices starting to take off, that’s been replaced by this huge shock that we’re getting in terms of energy prices, which comes from what Russia is doing,” he said.
Fee and price increases
Wave after wave of global shocks affects businesses, which push for price increases. As a result, workers seek higher wages. This may protect them from inflation, but it also threatens to embed price increases throughout the economy. Higher wages tend to lead to higher prices, risking a coveted wage-price spiral. “There were some signs that inflationary pressures are becoming more persistent and expanding to more domestically driven sectors,” the MPC said in its minutes. “Companies are finding it easier to raise prices and the labor market remains tight. In such an environment, there is a risk that a further rise in energy prices and a higher and more prolonged run of CPI inflation over the next 18 months could lead to more sustained domestic price and wage pressures.” This is the main threat against which the Bank is acting with the sharp rise in interest rates. “If we don’t act, inflation will become more embedded, it will get worse and we will have to raise interest rates further,” Mr Bailey said.
