Inflation vs Interest Rates

Financial Planning

There is always a fascination surrounding inflation vs interest rates, and this period in time is possibly more interesting than usual. The relationship between inflation and interest rates is ordinarily inverse, so inflation increases while interest rates are low. However, current interest rates have stayed low, and inflation is rising. So what does this mean for the Bank of England & inflation, as they seek to curb inflation with an interest rate rise, and will this be effective in the current climate?

First, we look at how COVID-19 and inflation affect retail.

What do COVID & Inflation worries mean for retail?

The financial burden on the average consumer seems to be increasing daily. Food prices are rising, energy bills are on the up and National Insurance is about to increase.

At the same time, businesses are struggling with rising transport costs and labour shortages, which have been linked to both Brexit and the continuing Covid-19 pandemic.

This means that people have less money in their pockets at a time when many retailers are having to pass on rising costs to their customers, and according to the British Retail Consortium (BRC), prices look set to continue going up.

So what happens next, as retailers struggle with increased costs and rising inflation deters consumers from spending money?

Chief Executive of the BRC Helen Dickinson has called on ministers to take action, saying: The trajectory for consumer prices is very clear: they will continue to rise at a faster rate.

“The government should relieve some of these costs by looking for long-term solutions to resolve issues such as labour shortages.”

According to the latest BRC figures, shop price annual inflation rose from 0.3% in November to 0.8% in December. This was driven partly by increased food costs, with food inflation increasing from 1.1% in November to 2.4% in December last year.

Inflation-related problems for the retail sector are also compounded by continuing consumer worries over the Omicron variant, which is much more transmissible than previous coronavirus strains.

Figures from Springboard show that concerns over Omicron led to fewer people heading to the shops to take advantage of post-Christmas sales.

Footfall on UK high streets was 37.7% lower on Boxing Day 2021 than in 2019, while the number of shoppers in retail parks dropped by 40.2%. In shopping centres, meanwhile, footfall fell by 48.4%.

Of course, several factors could have contributed to this decline, such as some shops staying shut on Boxing Day, so their staff could enjoy a longer Christmas break, and Boxing Day fell on a Sunday in 2021. However, Covid was a significant factor behind people staying away, especially in cities such as London, where the number of shoppers on Boxing Day 2021 was 50% down on the same day in 2019.

Diane Wehrle, insights director at Springboard, said: “Footfall is weaker in central London than in large city centres elsewhere in the UK, which in part is likely to be a result of cancellations of trains restricting shoppers’ ability to get into the capital.”

This view is reinforced by data from the Rail Delivery Group, which said nearly one in ten rail workers across the UK are off work because they either have COVID-19 or are isolating. As a result, major operators, including LNER and CrossCountry, have had to switch to reduced timetables and warn of possible cancellations.

Rising cost worries over Omicron and transport issues making it harder for people to get to the shops all add up to a big headache for the UK’s beleaguered retail sector. This problem may require some level of government intervention in the coming months.

Interest rates vs inflation

The most common type of inflation is caused by excessive spending and an economy experiencing fast economic growth. A certain level of this inflation is healthy for a country’s economy, but too much of this can cause problems. In this scenario, the general solution is to increase interest rates. Doing this encourages savers to put their money away rather than spend it, and this slows down economic growth, which has the knock-on effect of reducing inflation back to manageable levels. So, will interest rates go up in 2022?

The UK interest rates have stayed very low since the global financial crisis of 2008 as the Government looked to lure us out of a deep recession and ensure that interest payments on eye-watering Government debt were as low as possible. Therefore, there is not much room for further decreasing interest rates, but plenty of scope to increase them. However, as mentioned above, the inflation we are seeing in the current climate is fuelled by supply shocks and the impact of COVID-19. Therefore, the general relationship between UK inflation and interest rates is broken down because raising interest rates will not necessarily resolve those two issues. This makes it a difficult decision for the Bank of England, but something must be done.

Looking at the most probable scenario, we will see interest rate rises during 2022 as a desperate attempt to curb high inflation. While the causes of this inflation are out of our control, increasing rates would likely have the effect of at least slowing the increase in prices. In the meantime, we must hope that our COVID issues can be resolved through vaccinations and that global supply issues find a quick resolution.

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