Money Talk logo

According to the Office of National Statistics, the inflation rate in the UK (using the Consumer Prices Index (CPI) in the 12 months to March of this year (the latest available figure) was 10.1%, which was slightly below the rate in February (10.4%); this following an annual rate overall of 9.1% during the calendar year 2022.

There doesn’t appear to be a great deal of agreement among economists as to what we should expect on this front for the rest of 2023: a few have suggested that the rate may come down to around 5% by the end of this year – which is essentially the figure which government ministers have been quoting recently - although there is still a lot of uncertainty, particularly in respect of energy prices world-wide.

While much of the world has experienced a recent surge in price inflation, the UK has suffered higher rates than most: the average across the Eurozone was 6.9% and in the US the rate was 5%. In fact, the UK headline rate is the highest in Western Europe. One part of the explanation for this is that we rely more than most countries on natural gas for heating and electricity production, although what is rarely acknowledged is that the UK created additional trade problems through Brexit, which inevitably resulted in additional costs for any business which depends on imports and/or exports – which means essentially every business.

This sort of persistent inflation rate is unusual by the standards of the last twenty years or so; indeed doesn’t seem that many years ago ( late 2014, for example) that it looked as if we might be heading into a prolonged spell of real price ‘deflation’ – i.e. a period when retail prices were actually falling year-on year. Which rather shows the fallacy of making any kind of long-term prediction on the basis of a short trend! From a rather longer historical perspective, the rates we’re seeing now, while high, are not exceptional; it’s well within living/working memory for at least some of us when inflation was rather higher, and for a longer period, albeit we’re talking about the late 1970’s and early 1980’s. So much so that in those days the financial and accounting bodies responded with all sorts of novel accounting practices (“Current Cost Accounting” and “Replacement Cost Accounting” for example) to try and make year-on-year accounting results and financial statements have some ‘real’ comparative value. Thankfully, we’re not quite into that sort of territory at the moment.

Having said which, it may be timely to remind those unfamiliar with the current inflationary rates that there’s one consequence of these conditions of which they ought to be aware. Imagine that you’re looking at your trading account over the last few months; does it look rather more ‘healthy’ than you might have expected? There’s a good chance that it does. The reason, of course, is down to windfall profits. Retailers hear of price rises and apply the new (higher) sales prices to stock that they may have bought a while ago, when the purchase cost of the products was lower. Bingo! Money for nothing. Especially if you’ve simply run-down existing stock without directly replacing it. Your trading account will look rather better than it had done for a while. And even when you buy-in new stock at its new (higher) price, all that happens is that the additional cost sits on your balance sheet as ‘stock’ until it’s sold. And then, if retail prices are still rising, the cycle repeats again… Unfortunately it is something of an illusion; while the trading profits are ‘real’ enough, they only go towards paying the overheads, which are themselves rising. So while ‘turnover’ and ‘Gross Profit’ may look healthier, the bottom line P&(L) doesn’t really benefit.

And while we’re on that subject, it is useful to remember that apart from making sure that you use the latest prices at the point of sale, you should also ensure that you keep updating the purchase costs of each product in your stock system. At least that way you’ll be able to see exactly how much more money you have tied-up in stock.

The other side of the coin to inflation is (seemingly inevitably) rising interest rates. That isn’t because of some fundamental ‘law’ of economics, it’s due to a deliberate policy adopted by almost every government for decades. Somewhere, a long time ago, politicians decided that the ‘best’ (or perhaps ‘only’-) tool that they could or would use to try and control inflation was by raising basic bank rates. This isn’t the place to explain or debate that, other than to say that there are situations when a particular underlying cause of inflation may indeed be such that raising borrowing rates is an appropriate response. No matter. As far as most governments are concerned, they only have to start thinking about inflation and they reach for the only tool that they recognise – get the central bank to increase borrowing costs for everybody.

The result is that consumers, already faced with continually rising prices for goods and services, see even more of their disposable income taken away to pay for their mortgages, bank loans and credit cards. And of course the same applies to retailers: borrowing costs rising while consumer spending is reduced. Depress the economy and hope that it eventually leads to a reduction in the inflation rate. In the short term, it tends to have the opposite effect; producers and retailers pass on their own increased costs to consumers, who (as employees) ask for higher wages, which feeds back into the pricing spiral. Eventually it seems to work – but at the expense of those with least ‘bargaining power’.

Which brings us finally to the recent comments by the Chief Economist of the Bank of England, Mr. Huw Pill: “So somehow in the UK, someone needs to accept that they’re worse off and stop trying to maintain their real spending power by bidding up prices, whether higher wages or passing the energy costs through on to customers. And what we’re facing now is that reluctance to accept that, yes, we’re all worse off, and we all have to take our share.”

It’s not something which any politician would be caught saying in public, and coming from someone who is (presumably) in a very well-paid job, with (again, presumably) a nice inflation-linked pension to which he can look forward in a few years, it may seem rather ‘insensitive’ – to put it mildly. But his logic is actually quite sound: most of the current inflation pressures we’re seeing are ‘imported’, which means that the UK economy isn’t fundamentally responsible for them. Hence putting up wages and prices to cover the effects is merely going to increase the inflationary spiral. So let’s hope that he remembers his own logic when the Bank of England next meets in a few weeks to review interest rates: increasing them (which most economists are taking for granted) will only add another turn to the spiral.

01942 816512