6 July 2021

The spectre of inflation is haunting Britain

By Elizabeth Dunkley

Inflation has been a thing of the past so long that it is easy to forget the brutal economic hardships of the 1970s, 1980s and early 1990s in the UK. Yet inflation is currently growing at its fastest rate in nearly 40 years prompting the outgoing Bank of England’s chief economist, Andy Haldane, to warn that the “beast of inflation is stalking the land again” with Britain at its most “dangerous moment” since Black Wednesday.

Already in the United States, inflation has reached 5% – far higher than anyone was predicting at the start of the year. The rise may be attributed in part to the effects of the Biden stimulus and partly to the release of pent-up demand.

History teaches that what starts in America often arrives in the UK sooner rather than later. At 2.2% inflation is currently nowhere close to the levels seen in the 1970s, but it is still higher than the target rate, and incidentally, higher than was predicted by central bankers in January.

Since the start of the year key indicators have shown signs of growing inflationary trends. House prices have risen by more than 5%, gas by 10%, food by 39.7%, and petrol by 30%. Manufacturing, broadband and transport costs are also rising. One global indicator, the price of copper, has shown an even steeper inflationary trend, rising by 26%.

The current view of the majority of mainstream economists is that the rise in inflation is a result of an imbalance between flourishing demand and constrained supply, as economies emerge from the Covid lockdowns. These price rises, they claim, are merely “transitory” and to be expected as lockdown is lifted and life returns to something approaching pre-Covid normality. The main drivers of inflation, including shortages of raw materials and essential components in cars and computers are likewise partly attributed to non-recurring “base effects” as a result of weak prices experienced during the pandemic, which will shortly fall out of the annual calculation of the consumer price index.

But remember, very few of the world’s leading economists and financial institutions predicted the financial crisis of 2008. And although the jury is still out, many of the dire economic consequences they predicted should the UK leave the EU have not come to pass. If they were wrong then, might they be wrong now?

Modest inflation isn’t necessarily a bad thing; indeed, the primary *goal* of monetary policy is to deliver 2% a year inflation. But once inflation is unleashed, it can be hard to contain. Out of control inflation is a hidden tax – it raises the cost of living, and reduces the value of savings and retirement nest eggs.

In a recent interview with Andrew Neil, Rishi Sunak claimed taking a view on inflation was the Bank of England’s job, not his. But if inflation continues to rise, that position will become untenable. Throughout the pandemic, he’s relied on the Bank of England to finance unprecedented deficits. The consequence is that any rise in the Bank Rate will add hugely to the Government’s debt servicing costs. In March, the ONS estimated the impact of a percentage point rise in inflation, interest rates and UK government borrowing costs: it was £25bn. That’s half the education budget and twice the policing budget.

High levels of spending could be forgiven during a global pandemic but if, as looks likely, they continue with a spendathon that would make even Jeremy Corbyn blush, there will be electoral consequences.

Tory voters want and expect a Conservative government to run the economy well. And so they should – they have a lot to lose if inflation does spiral out of control. Pensioners and those with savings will see the value of their hard work wither away. Meanwhile, home owners (which is the biggest indicator of whether or not someone will vote Conservative), only a minority of whom have ever experienced a rise in borrowing costs or any sort significant inflation, will also take a hit.

Similarly, if inflation were to rise above 4%, as predicted by Andy Haldane, the average household stands to see their income reduced by £700 a year, with lower income Red Wall families among the worst affected. Red Wall voters lent the Conservatives their vote with the expectation of tangible change for the better, not to be made worse off.

An important lesson from history is that inflation typically starts looking localised and temporary but can quickly spiral. With localised price pressures turning into generalised ones, temporary spikes in price become more persistent which in turn causes people’s expectations of inflation to increase. This dynamic process has been seen time and again in economic history. If clear warning signs begin to appear, policymakers need to act swiftly and decisively to nip things in the bud.

Failing to do so will mean being forced to play catch up, raising interest rates faster and higher than would otherwise be necessary, risking the pandemic being followed by another financial crash.

The Conservatives have been punished before for mismanaging the economy. Public opinion dropped sharply in the aftermath of Black Wednesday and it took 15 years for the public to begin to trust them again. If inflation does begin to bite and the Government is seen to have failed to act, or worse caused price rises to accelerate, Johnson’s government will have nowhere to hide.

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Elizabeth Dunkley is a researcher at the Centre for Policy Studies