Will inflation in the UK keep rising?
The BoE expects the rate of inflation to rise to about 6% by spring 2022. It will start to come back down again quickly from the second half of 2022 and continue to keep falling in 2023. That is because most of the causes of the current high rate of inflation won’t last. Many of them are related to the effects of the Covid pandemic on the economy.
Why has the rate of inflation in the UK gone up?
There is more than one reason why the rate of inflation started to rise in 2021. A lot of it was to do with the economy recovering from the Covid crisis.
When the UK opened up after Covid restrictions eased, people naturally wanted to start buying things again. But the people selling some of these things have had problems getting enough of them to sell to customers. This block in the supply caused prices to rise during 2021.
There were also unexpected events, like flooding, which slowed down the production of all sorts of electronic goods.
Added to those factors was a very sharp rise in energy (oil and gas) prices. All of these things have pushed up prices and will continue to be reflected in the annual rate of inflation over the coming year.
Should I be worried?
The BoE expects the inflation rate to reach around 6% by spring 2022. That is much higher than normal, and many people are worried there will be a return of the high rates of inflation that the UK experienced in the 1970s. But the BoE is confident that inflation will not get anywhere near those levels this time although it expects inflation to stay high over the coming year, then start to fall back towards 2%.
Despite BoE’s reassurances, one should be cautious and prepare for a significant increase in their cost of living given many commentators have criticised central banks, including Federal Reserve, for getting their inflation call so wrong. Inflation forecasts were revised up throughout 2021 and some experts think price growth could remain high for longer than currently expected.
The financial markets expect interest rates to rise three to four times by end of 2022; some analysts expect seven incremental rate rises before end of 2023. Any rise in the rate of interest has significant impact on cost of living for many people, particularly those on low income. The UK government has indicated its willingness to intervene and subsidise energy costs, however, the looming rise in national insurance contributions and return of 20% VAT in April 2022, supply chain disruption and continuation of the pandemic are likely to keep prices high until 2024. Against this backdrop, people with low income will struggle to make ends meet.
The chart below shows historical trend since January 1989:
How could it impact me?
Given the Bank of England is under pressure to tame rising inflation by tightening monetary policy, it is likely that the BoE will take a bold step and raise interest rate, albeit marginally, by March 2022. Savers will welcome this decision, however, those with credit card debt, bank loans and mortgages on variable rate will pay increased monthly repayments.
The BoE may raise interest rates gradually perhaps two or three times during 2022. High street lenders will most probably follow suit and increase their lending rates. Given mortgage payments account for a bigger portion of one’s monthly household expenditure, several rises in interest rates will put undue strain on personal finances. One could manage this looming challenge by revisiting monthly household expenditure, preparing a budget and finding additional source of income, if possible.
The table below shows, in simple terms, how a rise in Bank of England Base Rate will increase interest charges on an interest-only mortgage or loan on a yearly basis:
|
Loan amount |
Current BoE base rate |
Current interest charges, per annum |
|
Loan amount |
Forecast rate of interest |
Estimated interest charges, per annum |
|
£ |
% |
£ |
|
£ |
% |
£ |
|
|
|
|
|
|
|
|
|
£100,000 |
0.25% |
£250 |
|
£100,000 |
0.75% |
£750 |
|
£200,000 |
0.25% |
£500 |
|
£200,000 |
0.75% |
£1,500 |
|
£500,000 |
0.25% |
£1,250 |
|
£500,000 |
0.75% |
£3,750 |
|
£750,000 |
0.25% |
£1,875 |
|
£750,000 |
0.75% |
£5,625 |
|
£1,000,000 |
0.25% |
£2,500 |
|
£1,000,000 |
0.75% |
£7,500 |
|
£5,000,000 |
0.25% |
£12,500 |
|
£5,000,000 |
0.75% |
£37,500 |
|
£10,000,000 |
0.25% |
£25,000 |
|
£10,000,000 |
0.75% |
£75,000 |
For repayment mortgages, monthly or yearly payment would be different depending upon the remaining term of the mortgage.
Even if the BoE did not raise interest rates significantly on the assumption current inflation is transitory, the severe supply constraints will push price of goods and services upwards for a foreseeable future.
What does this mean for businesses?
Some businesses may have benefited from rising inflation as people have spent more money, however, when interest rate go up, consumers may retreat and spend less.
Many businesses, particularly those sectors that have not recovered from the pandemic, will face challenges when they start repaying existing or new loans taken out during the pandemic. Unless those loans were agreed at a fixed/capped rate, a rise in interest rates will increase interest charges and total repayment amounts. The ongoing supply chain issues, labour shortages, exorbitant energy prices, recent geopolitical uncertainty, a rise in national insurance contributions and return of 20% VAT in April 2022 will pose serious challenges to business owners. It would be useful to carryout “what if” analysis and prepare cash flow forecast to ascertain financial distress that may lie ahead.
