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Inflation and energy costs squeeze budgets

The factors contributing to inflation and the UK's cost of living crisis

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Image Credit: J. H. Janssen

Inflation, as many will be aware, is a term used to describe how, over a year, the prices of most items go up. Strictly speaking, controlled inflation is a sign that the economy is healthy provided that it’s kept in line with minimum wage. If this is the case, it means that people like you and I (who may have little disposable income) can continue to live. Ordinarily the Bank of England sets an annual target of 2 percent inflation each year. But with inflation being at its highest rate for 30 years, at 5.4 percent as of February 2022, many of us are asking how it got so out of control, affecting not only mean low income households, but having similar effects for the wealthier amongst us too.

In recent times, increasing energy prices have had the most profound impact on interest rates. With the price of gas having gone up by an average of 28.1 percent for suppliers between the period of December and February, the 18 million UK households currently on a ‘standard tariff’ will see an average increase of £693 on their energy bills. Alternatively, those 4.5 million households on a prepayment plan will see an average increase of up to £708. This is in order to foot the bill for the higher costs faced by energy suppliers after the energy price cap is removed in April.

There are many factors contributing to this enormous increase in cost. In fact, there are too many factors to discuss in this article alone, but here is a brief outline of why costs have surged so much. A cold European winter in 2020/21 caused consumption of gas to go up and the amount stored by energy suppliers to decrease; and a ‘windless’ summer in 2021 made it difficult to generate alternative ways of powering households; and finally, an increase in demand from countries in Asia, such as China, put even more strain on already pressured gas supplies.

With 85 percent of UK households relying on gas to heat their homes, and a third of our country's energy being generated by gas, many households are expected to succumb to ‘fuel poverty’. This means when they spend the required amount to heat their home, they are left with a residual income below the official poverty line. Now, with tensions between the majority of the western world and Russia - the world’s largest exporter of natural and liquefied gas - at breaking point, it is almost impossible to say whether the prices of gas will continue to rise or will begin to stabilise.

Another factor that has had a noticeable effect on the UK’s inflation rate is the labour shortage affecting  almost all sectors of the economy. The most notorious being the lack of workers in restaurants and other high street food suppliers as a result of the Covid-19 pandemic, as well as the dramatic decline in the amount of lorry drivers importing and exporting goods as a result of Brexit. Employers in these sectors, such as Pret a Manger and Sainsburys, have faced increased costs in running their businesses, and have had to increase wages to up to £10 per hour for their workers because of the problems many of them face. The increase in costs of labour and goods is once again shouldered by the customer who will face higher prices, contributing to inflation akin to that seen in the energy sector.

Inflation is typically tackled by the Bank of England through increasing interest rates. The theory behind this being that once the cost of borrowing is higher, people have less to spend, causing prices to stabilise as a result. Only recently has the Bank of England announced that it will be increasing the interest rates from 0.25 percent to 0.5 percent in order to tackle inflation and reduce it to its usual target of 2 percent within two years. But many question whether this is the right response to tackle inflation due to it being caused by more external factors such as increases in the global price of energy. The government may instead choose to cut tax for people and introduce measures to help reduce costs of energy.

With Rishi Sunak recently announcing that there will be a government scheme paying back £200 on people's energy bills, as well as a council tax rebate of up to 80 percent for people with houses in band A to D, it is clear this may be the approach they are taking. The effect of this approach remains to be seen, and much uncertainty as to its success remains.

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