The UK government can’t stop inflation rising – but it can act to ease the pain | Carsten Jung

In late summer there was a sense of hope for the UK economy, as Covid restrictions were lifted and jobs started to return. But more recently the clouds have started gathering again: prices for certain goods (such as petrol and gas) are going up and, in some cases, goods have even disappeared from shelves. Why is this happening?

At the heart of this current increase in prices are global factors – most importantly the “supply chain squeeze”, the “global energy squeeze” and the “Covid bounce”. All three are hitting many countries at the same time and are testament to just how connected our world economy is.

The most important factor putting pressure on prices is the global energy squeeze; we are seeing increasing prices for gas, petrol and coal. Global demand for fossil fuels is rebounding strongly as the pandemic eases – and it is conspiring with a few other factors. Among them is that the last winter was unusually cold, which not only increased demand for gas in homes in the UK but also across the globe, driving up prices internationally. Moreover, Russia is supplying less gas than expected, possibly for political reasons, further increasing prices. Oil prices too have shot back up to pre-pandemic levels. All the while, the UK government has made disappointingly slow progress in insulating its homes and building transport infrastructure that does not require fossil fuels. Had there been more progress on the phasing out of fossil fuels from our economy, the energy squeeze would be hitting us less hard.

The supply chain squeeze too is pushing up prices, as a lot of goods around the world are not as readily available as they usually are. At the heart of this is that freight ships are not in the right places, as well as the lingering effects of Covid lockdowns in many countries. There are fewer container ships right now transporting goods from China to Europe and the US as would be needed. This is causing increased shipping prices and means fewer goods are being delivered than consumers are demanding. And some specific goods are in short supply. Take for example the shortage of semiconductors: these small chips that run our computers and cars are the world’s fourth most traded good. Demand for them skyrocketed during the pandemic all the while their production, in Taiwan and Malaysia, was affected by Covid shutdowns.

Next comes the global Covid bounce. Prices are going up as the global economy kicks back into gear. People are buying cars and petrol to fuel them, they are returning to hotels and malls. As a result, businesses are cautiously ending their customer discounts from the past year. Indeed, inflation went up significantly in the UK compared with a year ago partly because Rishi Sunak’s “eat out to help out” scheme had reduced prices last August. Much of this is positive: it shows that many people’s incomes have held up until now, and that businesses are feeling demand for their goods is coming back.

There are also some other factors more specific to the UK pushing up inflation. The UK is experiencing labour shortages in some sectors – most prominently HGV drivers, including those delivering petrol. This is due to longstanding shortcoming in training and working conditions. But it also because a lot of people have dropped out of the labour force, with young people going into education and older people retiring. It has been exacerbated by the government’s Brexit plan, which has reportedly shut many drivers out. The UK also has a worse gas price problem because its system has been marred by low storage capacity and operational problems. However, it is global factors that are relatively more important, making it difficult for the government to do much to stop the short-term rise in inflation.

As a result of these pressures, UK inflation has hit 3% in the year to August, and the Bank of England is expecting it to reach 4%, and possibly more, by the end of the year. This would be twice the intended rate.

Though the factors driving up inflation are varied, most of them are expected to reverse by the middle of next year. Problems with shipping may now have peaked, while producers are investing in producing more semiconductors. Russia said it is ready to raise gas supply. However, this cannot be taken for granted.

In the face of this inflationary pressure, the question is whether anything can be done at home to mitigate it? The Bank of England is tasked with keeping inflation in Britain at the 2% target, but its options are limited as it obviously cannot control those global factors. It has to walk a tightrope. It might soon start to reverse the cheap financing conditions introduced during the pandemic, easing price pressures. But if it does so too abruptly, it could choke off the recovery and do more harm than good.

While options to halt inflation rises are limited, the government, meanwhile, does have the means to alleviate some of the problems it is causing – especially addressing the cost-of-living crisis for low earners. Firstly, the government should reverse its decision to cut universal credit which is slashing the incomes of 5.5 million families by £1,040 a year. The combination of high inflation and the benefits cut means that, for example, a working single parent who is reliant on universal credit could see their real income fall by 7%. It is the biggest overnight cut to social security since the foundation of the welfare state and it needs to be reversed.

Second, the government should increase public investment to support the recovery while also addressing some of underlying domestic pressures that are contributing to inflation. Public investment should increase, with a boost to green infrastructure. This could generate 1.6 million green jobs, while easing inflationary pressures caused by volatile energy prices. Other investment should go into social infrastructure, including skills and education, to address the UK skills shortage.

Being better prepared for the next crisis has been a salient lesson of the last 18 months: while global underlying factors aren’t going to simply disappear, the government still has things it can do to limit the risks from inflation in the future.

Carsten Jung is a senior economist at the Institute for Public Policy Research’s Centre for Economic Justice

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