Employer Insights

What is inflation?

Finlay Keith

Senior Consultant | Finance

Aug 07, 2023

Over the last year, it’s been impossible to avoid the term ‘inflation’; whether we’re talking about interest rates, mortgage costs, or the cost of living crisis, it seems to all reflect back on inflation.

But what does inflation mean in the context of UK finance, what are its causes, effects, and how it is managed by policymakers?

Understanding Inflation in the UK:

Inflation is a critical economic indicator that significantly affects the financial landscape of any country, including the United Kingdom. As prices rise over time, the purchasing power of money declines, impacting consumers, businesses, and investors alike.

In the UK, inflation is measured using the Consumer Price Index (CPI), which tracks the price changes of a basket of goods and services commonly purchased by households. The CPI provides insight into the cost of living and inflation rate in the country.

Causes of Inflation in the UK:

  1. Demand-Pull Inflation: In periods of strong economic growth and increased consumer spending, demand for goods and services may outpace supply, causing prices to rise.
  2. Cost-Push Inflation: Rising production costs, such as wages, raw materials, and energy, can lead to cost-push inflation. Businesses may pass these increased costs onto consumers, resulting in higher prices.
  3. Exchange Rates: Fluctuations in exchange rates can impact the cost of imported goods and commodities, influencing inflation levels in the UK, which relies on imports for many products.

Effects of Inflation on UK Finance:

  1. Purchasing Power: As inflation rises, the purchasing power of the pound decreases. Consumers may find it challenging to maintain their standard of living with the same income, leading to reduced spending and a potential slowdown in economic growth.
  2. Interest Rates: The Bank of England, as the central bank of the UK, uses interest rates as a tool to manage inflation. When inflation rises above the target rate (usually 2%), the Bank of England may increase interest rates to curb spending and reduce inflationary pressures.
  3. Investment Decisions: Inflation can impact investment decisions, particularly fixed-income investments like bonds. Rising inflation erodes the real returns on these investments, potentially driving investors towards riskier assets like equities.
  4. Cost of Borrowing: Borrowers are affected by inflation as well. While inflation can reduce the real value of debt, lenders may respond by increasing interest rates to preserve their returns, making borrowing more expensive.

Managing Inflation in the UK:

The Bank of England plays a crucial role in managing inflation through its Monetary Policy Committee (MPC). The MPC sets the official interest rate (Bank Rate) with the aim of achieving the government's inflation target. Additionally, the Bank of England uses other policy tools, such as quantitative easing, to influence the money supply and, consequently, inflation.

Overall, inflation is an essential aspect of UK finance, shaping the economy's performance and impacting various stakeholders. Understanding the causes and effects of inflation is crucial for individuals, businesses, and policymakers to make informed financial decisions. As the Bank of England closely monitors inflation, its' actions in managing interest rates and implementing monetary policy, play a vital role in maintaining economic stability and ensuring the long-term financial well-being of the UK.

So how does inflation effect Local Authorities and the wider public sector?

Inflation has significantly impacted local authorities in various ways; it has lead to rising costs of essential goods and services, affecting the budgets allocated for public services like education, healthcare, and infrastructure. This results in reduced funding for crucial projects and services, hindering overall development. Additionally, inflation erodes the purchasing power of local authority funds, making it challenging to maintain the same level of service quality.

As prices rise, local authorities may also face difficulties in attracting and retaining skilled staff due to inadequate salary adjustments. Managing inflation effectively becomes crucial for sustaining efficient public service delivery and maintaining the well-being of the community.

Inflation is one of the most prominent influences which has led many Local Authorities to be in danger of issue Section 114 bankruptcy notices, as they have simply not been able to cut spending to levels that would not threaten their ability to provide adequate service.

Seemingly the only way Local Authorities have been able to deal with the issue, is to cut essential services or burn through their financial reserves, earmarked to secure the financial future of these organisations. Either way, the issue of inflation threatens the very existence of many Local Governments and the sector as a whole faces a tough few years ahead navigating it.

Feel free to reach out to me to discuss this further, any insights are useful - Finlay.keith@oysterpartnership.com

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Senior Consultant | Finance

Finlay Keith

Finlay started his recruitment journey at Oyster in 2022 and is the perfect fit for the finance team with his dry, reserved sense of humour and quiet manner. Finlay is resolute in his ambition to grow his network and works diligently to get results.

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