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What are the implications of the high rate of UK inflation?

The latest figures show that CPI inflation in May remained at 4.5% as can be seen in the graphic below. At the same time RPI annual inflation was 5.2% and RPIX annual inflation, which excludes mortgage interest payments, was 5.3%. The UK CPI figure of 4.5% is well above the current EU average of 3.2%.

Source: ONS

Because high inflation has reduced real disposable income, we have already seen a large drop in the latest retail sales figures, with implications for food retailers and other shops.

Also, the Institute for Fiscal Studies (IFS) has recently published a report into how inflation affects different segments of UK society. This study found that the poorest UK households, covering a fifth of the population, faced an inflation rate of 4.3% over the two years between 2008 and 2010. However, the rest of the population had an effective inflation rate of only 2.7%. Also, pensioners have had to deal with a higher inflation rate than non-pensioners.

This means that because of the nature of their spending patterns, and the higher weighting on items such as food and fuel, the poorest sectors of society have to bear a greater burden of inflation than the rest of the population.

Also noted in the IFS report was the fact that energy prices have more than doubled in the ten year span from 2000 to 2010. According to an IFS spokesperson: “Our modelling suggests that the average household in the poorest fifth of the population will reduce fuel consumption by 6% in the face of a 10% fuel price increase. Amongst the richest fifth, by contrast, we estimate the average response to be unchanged fuel consumption. This suggests that if prices do rise in the future spending on fuel will increase on average more for higher income households than for lower income households, but that, at least in the short term, lower income households will heat their homes less.”

Bad news for the pensioners and bad news for the poorest in society. What are interesting figures to economists, can mean the difference between life and death for some.

However, the Bank of England remains relatively unperturbed by current inflation levels. In the Quarterly Bulletin published last week they looked at the importance of inflation expectations. Of course, if people expect inflation to remain high this will alter their patterns of behaviour including fuelling demands for higher wages.

According to the Bank, people expect the inflation rate to come down in the long-term to 2% from 4.5%, although in the short-term they note that expectations are what they call “elevated”. Unfortunately for many of our poorest this winter there will not be a “long-term”.

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Posted in Bank of England, Inflation

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