ICAEW chart of the week: Inflation around the world

This week we look at how inflation is racing upwards across the world, with the UK reporting in April one of the highest rates of increase among developed countries.

Bar chart showing inflation rates by G20 country: Russia 17.8%, Nigeria 16.8%, Poland 12.4%, Brazil 12.1%, Netherlands 9.6%, UK 9.0%, Spain 8.3%, USA 8.3%, India 7.8%, Mexico 7.7%, German 7.4%, Canada 6.8%, Italy 6.0%, South Africa 5.9%, France 4.8%, South Korea 4.8%, Indonesia 3.5%, Switzerland 2.5%, Japan 2.4%, Saudia Arabia 2.3%, China 2.1%.

Inflation has increased rapidly over the last year as the world has emerged from the pandemic. A recovery in demand combined with constraints in supply and transportation has driven prices, with myriad factors at play. These include the effects of lockdowns in China (the world’s largest supplier of goods), the devastation caused by the Russian invasion in Ukraine (a major food exporter to Europe, the Middle East and Africa), and the economic sanctions imposed on Russia (one of the world’s largest suppliers of oil and gas).

As the chart shows, the UK currently has – at 9% – the highest reported rate of consumer price inflation in the G7, as measured by the annual change in the consumer prices index (CPI) between April 2021 and April 2022. This compares with 8.3% in the USA, 7.4% in Germany, 6.8% in Canada, 6.0% in Italy, 4.8% in France and 2.4% in Japan. 

The UK’s relatively higher rate partly reflects the big jump in energy prices in April from the rise in the domestic energy price cap, which contrasts with France, for example, where domestic energy price rises have been much lower (thanks in part to state subsidies). The UK inflation rate also hasn’t been helped by falls in the value of sterling, making imported goods and food more expensive.

Other countries shown in the chart include Russia at 17.8%, Nigeria at 16.8%, Poland at 12.4%, Brazil at 12.1%, Netherlands at 9.6%, Spain at 8.3%, India at 7.8%, Mexico at 7.7%, South Africa 5.9%, South Korea at 4.8%, Indonesia at 3.5%, Switzerland at 2.5%, Saudi Arabia at 2.3% and China at 2.1%. For most countries, the rate of inflation is substantially higher than it has been for many years, reflecting just how major a change there has been in a global economy that had become accustomed to relatively stable prices in recent years. 

This is not the case for every country, and the chart excludes three hyperinflationary countries that already had problems with inflation even before the pandemic, led by Venezuela with an inflation rate of 222.3% in April, Turkey with a rate of 70%, and Argentina at 58%.

Policymakers have been alarmed at the prospect of an inflationary cycle as higher prices start to drive higher wages, which in turn will drive even higher prices. For central banks that has meant increasing interest rates to try and dampen demand, while finance ministries have been looking to see how they can protect households from the effect of rising prices, particular on energy, whether that be by intervention to constrain prices, through temporary tax cuts, or through direct or indirect financial support to struggling households.

Here in the UK, both the Bank of England and HM Treasury have been calling for restraint in wage settlements as they seek to head off a further ramp-up in inflation. They hope that inflation will start to moderate later in the year as price rises in the last six months start to drop out of the year-on-year comparison and supply constraints start to ease, for example as oil and gas production is ramped up in the USA, the Middle East and elsewhere to replace Russia as an energy supplier, and as China emerges from its lockdowns.

Despite that, prices are likely to rise further, especially in October when the energy price cap is expected to increase by 40%, following a 54% rise in April. This is likely to force many to make difficult choices as household budgets come under increasing strain.

After all, inflation is much more than the rate of change in an arbitrary index; it has an impact in the real world of diminishing spending power and in eroding the value of savings. 

This chart was originally published by ICAEW.

ICAEW chart of the week: Real interest rates

The ICAEW chart of the week looks at how real interest rates – net of inflation – remain stubbornly negative despite recent increases in the Bank of England base rate.

Chart with three lines - nominal yields on government debt, the Bank of England base rate and real yields on government debt. See text for details.

A feature of the economy since the financial crisis has been negative real interest rates, with the Bank of England reporting a -2.33% implied spot yield on 10-year government gilts as of 30 April 2022. This compares with a base rate of 0.75% on that day (since raised to 1%) and a nominal yield of +1.9%. With further increases in interest rates likely as the Bank of England seeks to bring inflation under control it is possible that real interest rates will become less negative over the next few months, at least assuming inflation peaks and doesn’t accelerate out of control.

Negative real interest rates are generally considered to be stimulative to the economy, reflecting the monetary policy support that the Bank of England has been providing since the financial crisis almost a decade and a half ago. Economic theory suggests that this should encourage spending and investment, as the nominal interest earned on savings will not be sufficient to offset the erosion in the value of money as prices rise over time.

The chart highlights how real interest rates were -2.59% in January 2020, before falling to almost -3.08% in June 2020 and bouncing around between -2.50% and -3.00% until November 2021 when they fell to -3.33%. They have since increased to -2.33% in April and to -2.20% as of 10 May 2022. Over that same period, nominal interest rates similarly based on government bond yields have fallen from 0.53% in January 2020 to 0.13% in July 2020 before increasing to between 0.3% and 0.4% until January 2021 after which they bounced between 0.8% and 1.0% until December 2021 since when rates have gradually increased to 1.92% on 30 April 2022, falling slightly to 1.86% on 10 May 2022. During this time, the Bank of England base rate was reduced from 0.75% in January 2020, to 0.25% and then 0.10% in March 2020 where it stayed until increasing to 0.25% in December 2021, to 0.50% in February 2022 to 0.75% in March 2022 and to 1.00% in May 2022.

The yields used in the chart are only one way of measuring real and nominal interest rates, and it is important to note that the former depend on the inflation expectations of market participants at particular points in time, which are not the same as the actual rates of inflation that are or will be experienced.

The challenge for the Bank of England over the next few months in tackling the current surge in inflation is how to take away the economic stimulus theoretically provided by negative real interest rates without causing a collapse in asset prices and a potential recession. A series of tough calls for even the most hardened policy makers.

ICAEW chart of the week: Consumer Prices Index

My chart this week looks at how price rises have accelerated over the last few months, with consumer price inflation reaching 4.2% in October, the highest it has been for a decade.

Line chart showing how the Consumer Prices Index has increased from 106.7 in Oct 2018 to 107/6 in Apr 2019 to 108.3 in Oct 2019 (a +1.5% increase over a year earlier) to 108.5 in Apr 2020 to 109.1 in Oct 2020 (up 0.7% over the year) to 110.1 in Apr 2021 to 113.6 in Oct 2021 (a 4.2% annual increase).

The Office for National Statistics published its latest estimates for inflation on Wednesday 17 November, reporting a 12-month increase in the Consumer Prices Index (CPI) of 4.2% and a 12-month increase in the Consumer Prices Index including owner occupiers’ house costs (CPIH) of 3.8%, both of which are the highest they have been since November 2011 when CPI was 4.8% and CPIH was 4.1%.

CPI and CPIH are calculated using a basket of goods and services to assess the level of inflation experienced by consumers, with the current index set to 100 in July 2015.

The ICAEW chart of the week shows how CPI fell before increasing from 106.7 in October 2018 to 107.6 in April 2019 and 108.3 in October 2019, an annual increase of 1.5% that was within the 1% to 3% Bank of England target range. This was followed by smaller increases to 108.3 in April 2020 and 109.1 in October 2020, a 0.7% annual increase in CPI driven in part by the pandemic. The index hovered around that level for several months until starting to increase more rapidly from March onwards as the economy started to re-open, reaching 110.1 in April 2021 and continuing to increase sharply to 113.6 in October 2021, an annual increase of 4.2%.

The Governor of the Bank of England is required to write to the Chancellor of the Bank of England whenever inflation is more than 1% above or below the 2% target and he did so on 23 September when inflation reached 3.2% and he will again now that it has reached 4.2%. Part of the explanation he has given and will give are ‘base effects’, where price discounting during 2020 at the height of the first and second waves of the pandemic suppressed some of the inflation that is being experienced now.

Further letters are likely over the next few months as even if prices don’t rise any further, given how the index bounced around the 109 level between September and March 2021. This means inflation should continue to stay substantially above 3% for the next four months or so unless prices were to fall again, which is unlikely given how global commodities and supply constraints continue to feed into rising domestic prices. A 12-month CPI-inflation rate of 5% appears more than likely at some point in the next few months.

The Bank of England’s Monetary Policy Committee (MPC) isn’t panicking at this stage given that the annualised rate of inflation over the last three years (comparing October 2021 with October 2018) is an almost on-target 2.1% and their expectation that inflation rate will come down once the flat inflationary period of a year ago starts to drop out of the comparison. However, they are sufficiently concerned about the steep slope in the CPI in the last few months to signal that interest rates may need to rise if prices continue to increase at the pace seen in recent months.

The MPC’s original plan was to hang tight through what they hoped would be a short inflationary spurt as the economy emerges from the pandemic. In the event it looks like they won’t be able to hold that line, with higher interest rates a distinct possibility in the coming months.

This chart was originally published by ICAEW.

ICAEW chart of the week: UK inflation

This week’s chart takes a look at UK inflation following news that the annual rate of inflation more than doubled in April to 1.5%, more than twice the 0.7% reported for the previous month.

Chart: CPI increasing from less than 0.5% in Apr 2016 to over 3% in Oct 2017 before falling to close to zero in Oct 2020, zigzagging to 0.7% in Mar 2021 and then jumping to 1.5% in Apr 2021. 

Compared with five year annualised rate gradually increasing from 1.5% in 2016 to close to just under 2% now.

The headline rate of inflation doubled this week from 0.7% to 1.5%, giving rise to concerns about the economic recovery. Economists aren’t getting worried just yet, but are they right to be so sanguine? 

This scale of this jump partly reflects the timing of the first and current lockdowns, as inflation is typically measured by comparing prices with the same month a year previously, with significant changes both this year as the UK started to emerge from its third lockdown and a year ago as it was entering its first. Some commentators have pointed out that the temporary cut in VAT on restaurant food and leisure activities help prevent the jump from being even higher.

Our chart compares the annual rate of Consumer Price Index (CPI) inflation with a more stable measure, which is the annualised rate of CPI inflation over a five-year period. This is less susceptible to short-term swings in the economy, but as the chart shows, medium-term inflation has been gradually rising over the past five years even as headline rates on an annual basis fell over the last four years before the pandemic.

This perhaps explains some of the relaxed responses from economists about the sudden burst in inflation in the last month, given the annual rate of increase still remains below the medium-term trend, despite the current extraordinary economic circumstances.

Of course, that is not to say that inflation might not become a problem as the UK emerges further from lockdown. Many businesses have closed over the last year, particularly in the retail sector, while those that have survived will be looking to repair their balance sheets – a recipe for higher prices as constrained supply meets higher post-lockdown demand from consumers. Only time will tell whether this will feed into sustained higher levels of inflation or will jump be a temporary adjustment that falls out of the headline rate again in a year or so’s time.