Why is inflation so high in the UK?

12 June 2023

Over the last year, inflation has never been far from the headlines. The soaring costs of fuel, energy, and food have seen prices rise faster than at any point since the 1980s, with the inflation rate hitting a peak of 11.1% in October 2022.

Indeed, Reuters reports that £5 in Britain today will only go as far as £4 did in 2019.

While the Office for National Statistics (ONS) reports that, in the year to April 2023, prices rose by 8.7%, the UK inflation rate remains stubbornly high – especially in international terms.

The Guardian reports that US inflation stood at 4.9% in April, while Eurostat says the Eurozone inflation rate is also lower than the UK, at 7%. Belgium has an inflation rate of just 3.3% while prices in Spain are rising at an annual rate of 3.8%.

So, why is UK inflation so high?

The biggest increase in energy costs in western Europe

The UK is a net importer of energy, meaning it is more exposed to global price shocks than other nations. Reuters reports that British consumer energy prices were 79% higher in March 2023 than their level two years earlier, the biggest increase in western Europe.

In addition, gas plays a far bigger role in the energy mix in the UK than in the US or Europe. Deloitte reports that 85% of UK households have gas boilers, compared to fewer than half of EU households, and that gas accounts for 40% of UK electricity compared to just 20% of EU electricity.

While the post-lockdown surge in oil and gas prices, exacerbated by Russia’s invasion of Ukraine, is partly responsible for the UK’s high inflation, many other countries have done more in response to soaring prices.

For example, France has a 4% cap on electricity price rises, helped by state ownership of the energy producer EDF. Italy has a windfall tax on energy firms and is spending €8 billion (around £6.9 billion) to shield consumers from higher bills. 

Spain and Portugal have capped gas prices after winning approval from the EU while Germany has cut fuel tax by 30 cents a litre, compared with a Britain’s 5p cut. 

Britain has a shortage of workers

Worker shortages are another factor contributing to high inflation.

Fewer foreign workers are seeking jobs in the UK after Brexit, while a rise in early retirement and long-term illness have depleted the pool of workers. 

In the spring Budget, the government acknowledged that the inactivity rate amongst 50- to 64 year-olds had increased by 2 percentage points since the start of the pandemic, while there are 410,000 more people reporting they are inactive due to long-term sickness since the start of the pandemic.

These labour shortages are leading companies to increase pay to attract and retain staff. These rises increase wage bills, leading businesses to raise the prices they charge for goods and services. The consequence is persistent inflation.

Inflation could remain above the Bank of England’s target until 2025

In response to double-digit inflation, the Bank of England (BoE) has responded by raising interest rates. The base rate has risen from just 0.1% in December 2021 to 4.5% in June 2023.

The theory is that this increases the cost of borrowing and reduces the demand for goods and services. Alongside encouraging households to save rather than spend, the aim is to bringing prices down.

In its latest forecast, the BoE says it expects inflation to fall to around 5% by the end of 2023. While it is likely that the prices of some things such as food will be rising faster than this, they predict energy bills should come down as wholesale gas prices have fallen significantly. They anticipate that inflation will return to the BoE’s 2% target by late 2024.

However, other experts believe inflation may be more embedded.

Think tank the National Institute of Economic and Social Research (NIESR) says that they expect inflation to fall only to 5.4% by the end of 2023 and not reach the BoE’s target of 2% until the third quarter of 2025.

Whatever the outcome, even if inflation has halved – in line with the government’s pledge – it will still mean that prices will be rising at more than twice the BoE’s target.

It’s worth remembering the key point that “slowing inflation” does not equal “falling prices” – it just means that prices are not rising as quickly as they were before.

If your savings are not keeping pace with the cost of living then your money will be losing value in real terms.

Royal London gives the example of holding £10,000 in a Cash ISA paying 0.96% interest. Based on a 5% inflation rate for 10 years, the real value of your savings will have reduced by a third – to £6,757 – over the decade.

Holding too much cash, where the rate of return is not keeping up with the rate of inflation – means your wealth is losing value in real terms. So, if you have a time frame of five years or longer, investing could give you the potential to outstrip cost of living rises and preserve the spending power of your wealth.

Of course, you need to remember that deposit-based accounts do provide good protection up to Financial Services Compensation Scheme (FSCS) limits of £85,000, per individual, per registered bank or building society. Investments carry risk, and the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Get in touch

If you want to protect your wealth in an environment of high inflation, we can provide advice and guidance. Email info@depledgeswm.com or call 0161 8080200.