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What Is Really Happening With Inflation?

Jeremy Hunt said the government plans to half inflation this year. (©UK Parliament/Andy Bailey)

5 min read

Inflation has been one of the central challenges facing the government as it attempts to improve the UK's gloomy economic outlook, and in Wednesday's Spring Budget, Chancellor Jeremy Hunt was keen to stress that his "plan is working" to bring it down.

In November consumer price index (CPI) inflation peaked at a 41 year high of 11.1%, and while it has since reduced it still remains high at 10.1%. 

Living standards are expected to drop by a cumulative 5.7 per cent in 2022/23 and 2023/24 – the sharpest drop in living standards since record began. 

While Hunt confirmed to MPs today that the UK will avoid the predicted "technical recession" this year, which is two consecutive periods of economic growth, overall the UK's GDP is expected to shrink by 0.8 per cent – the lowest growth in the G7. 

Hunt and Prime Minister Rishi Sunak have made halving inflation this year a key part of their economic agenda to tackle the UK's economic woes.

However, while the OBR does expect inflation to fall sharply to 2.9 per cent by the end of 2023, government policy is unlikely to be the driving factor.  

Here's what else is going on:

Falling Energy Prices

Gas prices soared following Russian president Vladimir Putin's invasion of Ukraine in February last year largely because Russia provided around 50 per cent of Europe's gas supplies. 

The average yearly household energy bill is now 120 per cent higher than it was 18 months ago – even with government interventions to cap the average yearly household energy bill at £2,500.

However, the price of gas has decreased significantly in recent months taking pressure off businesses which were being forced to pass on extra costs to consumers as prices rose. 

Last month, European natural gas prices fell to their lowest level since Russia's invasion of Ukraine. 

The drop in the price of gas is expected to have a significant impact on the level of inflation – with Peter Levell, associate director at the Institute for Fiscal Studies (IFS), telling PoliticsHome another energy price shock would be required to prevent inflation coming down sharply.

“There’s been a shock to energy prices, but in order for inflation to stay high there would be another shock to energy prices – and it's difficult to see where where that additional shock would come from,” said Levell.

“The cost of energy. that's a major factor in what's driving inflation – and indirectly that's affected the cost of production food [for example]… energy prices feed through [into businesses], especially food prices... it's not just energy [that's affected], but also things indirectly related to energy.

“It was already expected before this budget that inflation was going to come down considerably over the course of the coming year [because of falling energy prices].”

Inflation Being Compared To Last Year’s Already High Levels

CPI inflation is worked out by how much an average basket of goods has increased from the same date 12 months prior. 

Because prices have been elevated since the price of energy began to soar in spring 2022, in the coming months the percentage increase in inflation compared to last year will be lower as it is being worked out from a higher baseline. 

"Before Jeremy Hunt stood up at the despatch box, we already expected inflation to come down significantly," said Levell.

"The fact that the energy price increases have already happened, and from April [2023] we're going to be comparing the current price level to price level after those energy price increases came through [in April [2022], much of it is what we would expect to happen even if the Chancellor hadn't done anything."

April 2022 marked the beginning of the extremely steep increases in energy bills after Ofgem announced the average household yearly bill would rise from £1,277 to £1,971 – prompting the beginning of a raft of government measures to protect households from the rising cost of energy since. 

Energy Price Guarantee And Tax Freezes

The government's decision to keep the Energy Price Guarantee (EPG) at £2,500 until July and continue with the freeze on fuel and alcohol duty is projected to decrease inflation by 0.7 per cent in 2023/24. 

The EPG was set to rise to £3,000 next month, but the delay means a typical household is set to save £160. 

The decision to delay the rise came after experts and campaigners warned the increase could cause a spike in fuel poverty.

Without the EPG, the average yearly energy bill would have reached £3,549 in October and £4,279 in January.

The OBR has said that the EPG has already reduced peak CPI inflation by 2.5 per cent since it was introduced in September by Liz Truss and Kwasi Kwarteng.

In his budget, Hunt said the combined impact of the EPG and the freezing on fuel duty of alcohol and fuel “reduces CPI inflation by three quarters of a per cent this year”.

Bank Of England

Levell also said it is likely the Bank of England (BoE) will continue to play a role in keeping inflation down in the coming months. 

The BoE has increased interest rates steeply over the last year in response to rising inflation – with interest rates currently 3.5 per cent higher than they were 12 months ago at 4 per cent. 

"The Bank raising interest rates – it's impossible to know how much that is [going to be], but it's quite important that people know that the Bank is very vigilant about inflation, very careful," said Levell.

"The Bank is actively trying to ensure that this doesn't feed into higher inflation rates."

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