Inflation explained as rate hits 40-year high amid cost of living crisis

Rising food and energy costs have driven up prices at their fastest rate in decades.

Inflation explained as rate hits 40-year high amid cost of living crisis iStock
Many people are counting the cost of inflation.

Rising food and energy costs have driven up prices at their fastest rate in 40 years.

UK inflation increased to nine per cent in the 12 months to April, up from seven per cent in March. It was the fastest measured rate since records began in 1989, and the Office of National Statistics (ONS) estimates it was the highest since 1982.

Rocketing prices are set to hit Scots in the pocket in the coming months as the government faces calls for urgent action to help struggling families.

Professor Mairi Spowage, director of the Fraser of Allander Institute, a leading economic research unit at the University of Strathclyde, gave us the lowdown on what it all means.

How is inflation measured?

Inflation describes the increase in prices over time and is measured by the ONS on a monthly basis using the Consumer Prices Index (CPI).

Prof Spowage described the CPI as a basket of around 700 goods and services consumers buy and pay for.

“This includes things like food, fuel, clothing, hairdressers and furniture and comparing the prices to a year ago,” she said. “The difference between the prices is the inflation rate.”

What are the main drivers?

Inflation rose steeply in April, driven by the sharp climb in electricity and gas prices as the 54 per cent energy price cap came into effect.

Much of the jump is down to the high cost of energy on international markets, especially gas, although oil prices have also shot up.

This has also pushed up the price of many other items, including food, which are made or transported using gas and oil-based products. The war in Ukraine has also hit global food supplies.

Just getting around, including to work, has become more expensive for households too. Prices for both petrol and diesel are at record highs, although recently soaring prices for second-hand cars eased off slightly in April.

Prof Spowage added: “Anybody paying attention to their bills won’t be surprised by that.

“Petrol and diesel are continuing to rise at an unprecedented rate. Energy costs feed through to everything as it costs more to make and transport food and other products.”

How likely is a recession?

The British Chambers of Commerce warned “unprecedented” inflation could spark a recession later in the year. A recession by definition is when the economy contracts for two quarters in a row.

The Bank of England has a mandate to keep inflation below 2%, but governor Andrew Bailey has admitted to being helpless in the face of global pressures, including a spike in energy costs and the war in Ukraine.

Rising prices squeeze on the cost of living and wages are not keeping up, meaning people typically cut back discretionary expenses such as replacing their car, going to restaurants and on holidays.

This results in a slump in the economy because people don’t have enough money to spend.

Experts also said pressure will now mount on decision makers at the Bank of England to increase interest rates and help protect savings.

The BCC’s head of economics Suren Thiru said: “The marked acceleration in the headline rate in April reflected the continued upward pressure on prices from surging energy and commodity costs, as well as the energy price cap rise and the reversal of the VAT reduction for hospitality in the month.

“The scale at which inflation is damaging key drivers of UK output, including consumer spending and business investment, is unprecedented and means there is a real chance the UK will be in recession by the third quarter of the year.”

What is the government doing about it?

Chancellor Rishi Sunak faces calls to take urgent action on the worsening cost-of-living crisis.

Charities, think tanks and opposition politicians said the UK Government needs to do more for the poorest households, who are being hit hardest by inflation.

The Chancellor has already pledged around £22bn in support, including £9bn to deal with household energy bills and measures to mitigate the impact of April’s rise in National Insurance Contributions (NICs).

But pressure is mounting for immediate action, rather than waiting for the autumn budget, with inflation set to increase further this year.

Sunak said inflation is hitting countries around the world, and pointed to energy prices as a main culprit.

He said: “We cannot protect people completely from these global challenges but are providing significant support where we can, and stand ready to take further action.”

The government said it was handing out £150 council tax rebates for many homes and will take £200 off energy bills from October to be paid back automatically over five years.

Fuel duty has also been cut by 5p a litre in order to temper rises in petrol costs.

Charities argue the policies in place are nowhere near enough to counteract the increase in people’s bills. Those on the lowest incomes also spend most of their money on these essentials.

The Institute for Fiscal Studies economic think tank suggested the poorest households might be facing inflation of 10.9%. This is higher than average because they spend a larger portion of their money on heating and lighting their homes.

Prof Spowage said: “The measures are quite small compared to the prices we’re seeing. If prices increase hugely across food, fuel, gas and electricity, the most vulnerable will suffer the most.”

What else has been said?

Opposition parties and some Tory MPs want to impose a windfall tax on oil and gas companies which have enjoyed bumper profits as a result of high global prices.

The money raised would be used to alleviate the pressure on households.

At Prime Minister’s Questions, Johnson was repeatedly pressed on the issue by Labour leader Sir Keir Starmer.

Johnson said the government was “not, in principle, in favour of higher taxation” but promised a “sensible approach, governed by the impact on investment and jobs” – ministers have argued that a windfall tax would deter investment by the oil and gas giants.

“Of course we will look at all the measures that we need to take to get people through to the other side, but the only reason we can do that is because we took the tough decisions that were necessary during the pandemic,” he said.

The Prime Minister added: “We always knew that there would be a short-term cost in weaning ourselves off Putin’s hydrocarbons and in sanctioning the Russian economy.

“Everybody in this House voted for those sanctions. We knew that it would be tough but… giving in, not sticking the course, would ultimately be the far greater economic risk.”

What can people do to make ends meet?

Surveys show people were switching to cheaper energy alternatives and trying to control how much energy they use.

The Joseph Rowntree Foundation said parents are skipping meals to ensure their children can eat and others are cutting back on showers to save water.

Rebecca McDonald, the foundation’s senior economist, said: “Inflation has hit a 40-year high. Yet last month, with prices already climbing, the Chancellor chose not to uprate benefits in line with inflation, leaving the basic rate of benefits at its lowest for 35 years.”

One Tory MP hit headlines this week after she suggested people work more hours or get a better paid job to make ends meet.

“Some of the comments from politicians can be tone deaf,” Prof Spowage said. “It’s not like people don’t think of these things and how to manage better. A lot of people just don’t have that option.

“Some may be working two jobs and all the hours they can or have caring responsibilities. A lot of people cannot do any more.

“I think we’re at a point where help needs to be targeted at those vulnerable households who need to feed their families. There’s only so much you can do on your own. It shouldn’t be too much to ask for a wealthy country.”

How the picture is looking for the next 12 months?

Prof Spowage predicts there’s a difficult road ahead for the UK as rising prices fail to keep face with household wages.

Households are struggling under the weight of prices that are increasing faster than at any point in more than a generation, data showed on Wednesday.

“It’s quite hard to be optimistic,” Prof Spowage admitted. “There’s going to be a lot of people struggling.

“People in work are already turning to food banks to be able to cover their outgoings. There’s a scary number of people who don’t have enough to feed their families, heat homes and maintain a decent standard of living. Managing a broken washing machine, a roof repair away from getting into bother and there’s no buffer.

“Living standards have fallen more in one year than they have since the Second World War.”

What help is out there for Scots?

Advice Direct Scotland is the country’s national advice service, providing free advice on a range of issues including debt management and energy bills through its moneyadvice.scot and energyadvice.scot services.

The charity also provides a free benefits tool, including Scottish benefits, which can help people check what they are entitled to.

Visit Citizens Advice Scotland more information on benefits, debt, consumer issues and housing.