As the cost-of-living crisis intensified in 2022, inflation and interest rates featured regularly in the news. This is because the two are inextricably linked. Central banks, such as the Bank of England, have a mandate to maintain a low and stable inflation rate.
In the UK, following detailed economic modelling, this rate was set at 2% in 2003. Inflation of 2% seems like a distant memory as we haven’t seen this since July 2021.
The Consumer Prices Index peaked at 11.1% in October 2022 and has now fallen each month since, with January’s number being 10.1%. The consensus is that we are now past the worst. Even the Prime Minister is now on record saying that he wants to halve the rate of inflation by the end of 2023. Curiously, it’s not in his gift to deliver that. The Bank of England has the task of trying to control it via monetary policy. Increasing interest rates is their ‘go to’ tool to dampen demand and cool price rises. We have now seen a base rate increase each month since December 2021, rising from a record low 0.1% to 4% in that time. It’s worth remembering that we had a Bank Rate of 4% or more for much of the first decade of the millennium, and it was only a drastic response to the global financial crisis in 2008 that led to historically low interest rates for more than a decade.
Investment markets are pricing in further ‘tightening’ in the UK, US and Europe before central bank interest rates stabilise and potentially start to decrease towards to the end of this year.
The Bank of England projects that based on market interest rate expectations, inflation will return to the target of 2% within the next 12-24 months. Energy price inflation is already falling, but wage growth is likely to be the cause of inflation being more stubborn in the months ahead.
So that’s the background on the link between inflation and interest rates, but have you ever wondered what caused the start of the massive spike in inflation over the past 2 years?
Obviously, the war in Ukraine had an almost immediate impact on global energy prices and this drove UK inflation from 6% to 9% by April 2022. But how did we get from 2% to 6%?
In March 2021, 200,000 tonne container ship the MV EverGreen grounded in the Suez Canal and effectively blocked the main arterial shipping route from East to West, semi-paralysing the global supply chain.
Source: Julianne Cona (Instagram).
As if this wasn’t bad enough, ports around the world already looked like this, with ships anchoring for weeks before lockdown-hit docks could unload them.
People and businesses wanted goods, but they were stuck at sea, packed into containers floating off the coast or re-routing around the continent of Africa to avoid the Suez Canal traffic jam.
This played a massive part in pushing up the price of imports. Why?
Because a whopping 90% of all traded goods travel by sea, all 11 billion tons worth $14 trillion per year. A blockage like that creates major problems everywhere.
But now, global supply chains are moving freely again and the seaways are no longer clogged.
Free-flowing trade is one key reason inflation in goods, rather than services, is likely to keep falling throughout the year. Once the services side (wage growth) calms down now, inflation will once more be under control.
I’d like to end with a more positive thought for hard-pressed consumers. Remember, when inventories build up in company warehouses, there’s only one solution, sales! Don’t be surprised to see a lot of discounts over the next year as businesses look to shift excess stock.
I’ll expect you all to be avid watchers of live marine traffic maps from now on.
Should you wish to discuss this article in further detail, please do not hesitate to contact Barry by email or speak to your usual planner at Carbon.
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