Thursday 28 October 2021
Inflation is on the rise, and Rishi Sunak’s high-spending budget could push it up further. Will the Bank of England step in?
Hi, I’m Claudia and this is Sensemaker.
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Today: inflation is on the rise, and Rishi Sunak’s high-spending budget could push it up further. Will the Bank of England step in to rein it in?
Yesterday was a big day in UK politics: Budget Day.
The day when the government lays out its plans on taxes and spending.
After 18 months of turbulence thanks to Covid, this was a huge moment for the Chancellor, Rishi Sunak.
And despite all the challenges the economy has faced during the pandemic, he was bullish about the future:
“Employment is up, investment, is growing public services are improving, the public finances are stabilising and wages are rising.”Rishi Sunak, Sky News
The Office for Budget Responsibility, the body that analyses the government’s finances, found that the economy was recovering faster than predicted.
And higher growth means more money to spend.
So in yesterday’s Budget, Rishi Sunak was able to splash billions more on measures he said will help businesses and families.
But there is a cloud on the horizon: inflation.
The rate of inflation – the rise in prices – is high at the moment.
Energy prices are pushing up our gas bills, and supply chain issues are affecting the price of the things we buy in the shops.
More government spending means more inflation, too.
And there’s a danger Rishi Sunak’s spending spree could put a rocket under it.
The potential impact? Rises in the cost of living – people will have to spend more on food, clothes and energy bills. They can’t get as much for their money.
The Bank of England, the body whose job it is to keep a lid on inflation, is concerned about what’ll happen:
“The real danger and what they’re really concerned about at the moment, I think, is what happens to inflation expectations.”Jenny Scott, Co-Founder Apella Advisors, Tortoise
That’s Jenny Scott of Apella Advisors. She’s an economist who used to have a senior role at the Bank of England.
She says that the Bank is probably worried that the inflation we’re seeing right now could become more entrenched.
That’s because when people expect prices to rise further, they react in ways which affect inflation:
“So if you and I see these price rises in energy and we see petrol prices going up and, and, you know, we imagine we see the prices in shops going up, and then we think, well, hang on, it’s going to cost me. To live the way I want to live. I’d better go and ask for a pay rise.
And then if you get a pay rise that makes the cost of goods go up even more, and then you think well, I need another pay rise to compensate for that. And so the inflation spiral begins going upwards.”Jenny Scott, Co-Founder Apella Advisors, Tortoise
So, will the Bank of England step in?
Until recently, important people in government seemed relatively relaxed about the rise in inflation.
“People have been worried about inflation for a very long time. I’m looking at, robust economic growth. And by the way, those, those fears have been unfounded.”Boris Johnson, Sky News
And so did the Bank of England.
Its governor, Andrew Bailey, said he thought the rise was a blip:
“It will be very important that you know that this increased inflation is temporary. It’s seen to be temporary and therefore doesn’t become embedded.”Andrew Bailey, Channel 4
But last week he changed his tune, warning that if inflation kept rising he’d have to respond:
“As I said before monetary policy cannot solve supply side problems but it will have to act and must do so if we see a risk particularly to medium-term inflation and to medium-term inflation expectations and that’s why we at the Bank of England have signalled and this is another such signal that we will have to act.”Andre Bailey, G30 Meeting
The main lever the Bank of England can pull if inflation is getting out of control is the interest rate.
Here’s a quick rundown of how that works….
When interest rates rise, people decide to keep more of their money in the bank instead of spending it.
When fewer people are spending, there’s less demand for goods and services – and prices fall.
And according to Jenny Scott, the bank could increase interest rates soon. Borrowing would become more expensive:
“Every quarter, the bank does a big look at its forecasts and looks at the economy and does a real deep dive into things. And November is the next stage when it does that. So that’s often a chance to make an interest rate change because they’ve done all the work behind the scenes. So there is some speculation interest rates could rise then.”Jenny Scott, Co-Founder Apella Advisors, Tortoise
The Bank is independent from the government – so its experts make those choices about interest rates by themselves.
But in his budget speech Rishi Sunak signalled loud and clear that if the Bank did decide to raise interest rates, he’d be okay with it:
“I’ve written to the Governor of the Bank of England today to reaffirm their remit to achieve low and stable inflation, and people should be reassured they have a strong track record in doing so.”Rishi Sunak, Sky News
There’s a decent chance that the Bank could move soon – maybe next month – to raise interest rates to control inflation.
If it does, it will be quite a moment because rates have stayed below 1 per cent since the 2008 financial crisis.
But what do higher rates mean for you and me? Servicing debt – mortgages and loans – will become more expensive. And higher interest rates can mean people who’ve borrowed heavily getting into trouble. Suddenly, holding onto one’s property – a house, a car or a business – is a challenge.
So there’s a lot for the Bank of England to juggle.
Especially because there’s a risk that, if the economy suddenly weakens, increasing interest rates can make matters worse.
And when the economy slows, you need people to spend money, not save it.
Whatever the Bank chooses to do, it’ll have to strike a careful balance.
Today’s Sensemaker was written and produced by Ella Hill.
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