Why is inflation so high? 5 important takeaways from the past 3 years

Since the Covid-19 pandemic reached the UK in 2020, the rate of inflation has climbed significantly.

According to the Office for National Statistics (ONS), UK inflation stood at just 1.5% in March 2020. By 2022 it had reached double figures, peaking at 11.1% in October.

Now, as of April 2023, inflation stands at 8.7% – still significantly higher than the Bank of England (BoE) target of 2%.

The rate of inflation is a numerical representation, indicated by the Consumer Prices Index (CPI), of how much costs have risen in the country compared with the previous year. The CPI measures the price of more than 700 goods and services each month – from essentials to luxuries and everything in between.

So, what the recent rise in inflation really shows is what journalists are calling “the cost of living crisis”. You may have noticed household bills, leisure, holidays, and essentials like fuel go up in price since the pandemic – and this has been reflected by the double-digit inflation figures you’ve seen in the news.

With plenty of media noise around inflation, you might be asking yourself: “why is inflation so high, and when will it fall?”

While there’s no crystal ball that tells us what will happen in the future, we can help you get to grips with the UK’s inflation situation as it stands.

Read on to learn five important inflation takeaways from the last three years.

1. A “perfect storm” of global factors led to the UK’s high inflation rate

First, it’s important to tackle the “why” question on everyone’s minds.

Indeed, the inflationary conditions we have seen since 2020 have been caused by not one, but many factors that have coincided to create a “perfect storm” of rising prices.

Here are two of the weightiest factors that contributed.

The Covid-19 pandemic

With consumers spending and earning considerably less during lockdown, the UK Government introduced a “quantitative easing” strategy – simply put, “printing money” – necessary to keep the economy afloat. This included the furlough scheme.

Once spending surged after lockdown, though, an increase in capital circulating in the economy led to price hikes, as it essentially meant that there’s more money chasing not enough goods.

What’s more, supply chain issues are often cited as a main catalyst for inflation. With China and other key producers of goods still under strict lockdowns, demand began to outweigh supply, resulting in a rapid increase in prices.

The Russian invasion of Ukraine

In February 2022, Russian troops crossed the border into Ukraine, beginning a war that is still ongoing.

This war is one of the key causes of the soaring energy prices witnessed all over Europe, as Russian gas and oil supplies were cut short. Once again, low supply of these essential fuels meeting high demand means prices usually climb quickly.

2. It may take more than a year for inflation to reach the Bank of England’s 2% target

The Government has set the BoE a target inflation rate of 2%.

If inflation dips below 2%, this indicates a significant fall in consumer spending that means, as the BoE puts it, “companies could fail, and people could lose their jobs”.

Gradual, steady price rises are, in theory, a good thing to help the economy stay afloat. However, as we’ve seen in the past three years, fast-paced price rises can lead to a worrying financial situation for many families.

Now that we’re in these circumstances, the next question on your lips might be: “how long will it take for inflation to reach the BoE’s target?”

The truth is, it’s impossible to guarantee how long it will take for inflation to slow to 2%. Yet according to Forbes Advisor, forecasters agree that inflation will begin to come down in 2023 – something we have already seen in April – and that the Chancellor aims to cut the rate in half by the end of the year.

So, it could be more than a year before UK inflation reaches its 2% target – meaning it may be wise to prepare for continued rising costs throughout 2023.

3. A lower inflation rate doesn’t mean prices are “coming down”

As you read earlier, the rate of inflation had decreased from 10.1% in March to 8.7% in April 2023.

Inflation returning to single digits may come as welcome relief, but it’s important to understand the difference between “slowing inflation” and “decreasing prices”.

Remember: the rate of inflation indicates how much prices have risen year-on-year. So, while an 8.7% inflation rate is significantly lower than the previous month’s 10.1% rate, prices have still risen by 8.7% since April 2022.

The recent drop we have seen is not an indication of prices going down, but rather that they are growing more slowly. This is still good news – but it’s important to know the difference so you can manage your money accordingly.

4. Inflation has an impact on interest rates, too

When inflation rises, central banks usually raise interest rates too.

Such has been the case in the UK – the BoE has raised the base rate, meaning its central rate of interest, from 0.1% to 4.5% between December 2021 and May 2023. Raising interest rates, in theory, curbs consumer spending and helps to slow price growth.

However, it does mean that your mortgage, credit card debt, and other loans could have become more expensive throughout the past 18 months, and may continue to rise if the BoE increases the base rate again.

You can read our full insights into what rising interest rates mean for your money on our news page.

5. Financial savviness is essential in a time of wage stagnation and high inflation

Finally, in a time of high inflation, the importance of financial comprehension cannot be understated.

It’s not just rising prices that require careful navigation, but a gradual stagnation of wages could also be putting your wealth into more precarious circumstances than in previous years.

Indeed, UK wages have not generally risen in line with the cost of living. A study published by the Trades Union Congress in 2022 revealed that UK workers have been “missing out” on £4,000 in wage growth since 2007.

So, it’s crucial to understand that rising prices are just one part of the equation. Your own ability to match these costs, and how this could affect your long-term financial stability, is equally vital.

All this to say: understanding how your financial situation stands today is an essential first step towards creating a better future for your loved ones.

Get in touch

We’re here to help you put plans in place to reduce the effects of inflation on your wealth.

To get started, email us at enquiries@pen-life.co.uk, or call 01904 661140.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article.

All information is correct at the time of writing and is subject to change in the future.