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The chart that shows how fast the UK's inflation spike swept in


There is a chart in the OBR’s Autumn Budget report dramatically showing how swiftly inflation can sweep in.

It presents forecasts for the rise in consumer prices inflation over coming years from March 2020, March 2021 and now.

March 2020’s forecast of stable inflation was of the pandemic era but before the shock of lockdown, so we can disregard it as a ‘here’s what you could have won’ scenario.

It is the stark contrast between the forecasts from March and October 2021 that tells the story of a rapid and unexpected inflationary surge.

This chart from the OBR's Autumn Budget report shows how swiftly an inflation spike swept in. The yellow line shows what was forecast in March this year, the blue what is happening and is now forecast to come

This chart from the OBR’s Autumn Budget report shows how swiftly an inflation spike swept in. The yellow line shows what was forecast in March this year, the blue what is happening and is now forecast to come

We were still in lockdown when Rishi Sunak stood up to deliver March 2021’s budget, but the roadmap out of it had been published and it was already clear the economy was doing much better than expected.

The Office of Budget Responsibility forecast then was for inflation to climb rapidly back up to about the 2 per cent target by the end of this year, slip back a bit for the next few years, and get back to where we like it to be by 2025.

It looks as if a child has taken a pen to the chart 

The good news about the current forecast is that inflation is also tipped to return to the 2 per cent target by about 2025.

The bad news is that before then is a wild spike, which looks as if a child has taken a pen to the chart.

The OBR now forecasts inflation to soar to as high as 4.4 per cent in 2022, average 4 per cent across the whole of next year, and then start its decline towards normal levels.

This illustrates two things: firstly, how even the most measured of predictions can go wildly wrong quite rapidly, and, secondly, how an inflation shock can move fast. 

Zoom right out and the economy doesn’t look hugely different to how it did in March.

Back then we knew things were bouncing back, businesses had adapted remarkably well, the vaccine rollout had begun apace, we had a plan for reopening the economy, and the year had begun with lots of chatter about the Roaring Twenties.

Zoom back in though and some individual elements have combined to trigger an inflation surprise.

Among them, the energy price spike has sent bills leaping; the oil price has jumped and teamed up with a brief fuel panic to send petrol prices up; shipping costs have gone through the roof; and a HGV driver shortage has sparked further supply issues.

Coupled with all this has been an unexpected shift at a time of higher unemployment to a chunk of workers being able to demand higher wages, such as those in hospitality, delivery and lorry driving, and the trades.

This chart from the OBR shows how the base rate is now forecast to climb more quickly towards 0.75% by markets (solid blue line) and then stay there

This chart from the OBR shows how the base rate is now forecast to climb more quickly towards 0.75% by markets (solid blue line) and then stay there

Short term this is bad news for our finances, there won’t be many This is Money readers who aren’t feeling the inflationary effects right now. I know I am.

An inflation spike hits our spending power, makes us feel less wealthy, eats away at our savings – all cash rates are below CPI – and means our investments must work harder to do better than just stand still.

But if it’s short term (or transitory as central banks like to say) it’s painful but can be dealt with.

It’s when inflation sticks around or spikes even higher that we have a problem.

The usual solution to that is to raise base rate. But even as a long-standing interest rate hawk, who would like to see the Bank of England get rates off the floor, I struggle to see how that makes much of a dent in inflation driven by the outside elements listed above.

Nonetheless, the OBR stashed some rate rise worst case scenarios in the middle of its Autumn Budget report.

It said that current judgement ‘may prove too optimistic, and inflation may prove more durable, especially if people come to expect high inflation to continue and businesses raise prices to protect their profit margins or workers demand larger wage increases to maintain their purchasing power’.

So, it put forward the prospect of inflation peaking at 5.4 per cent and then falling back more slowly, with a basic historic-looking model showing the Bank of England raising rates to 3.5 per cent to tame it.

The OBR also sketched out the scenario where the inflation shock is worse than thought, with CPI rising all the way up to 5.4% (yellow vs blue) and base rate to 3.5% (yellow vs blue)

The OBR also sketched out the scenario where the inflation shock is worse than thought, with CPI rising all the way up to 5.4% (yellow vs blue) and base rate to 3.5% (yellow vs blue)

Two separate scenarios for this were sketched out: a product market supplier-driven spike and a labour market pressure one.

The OBR then modelled out what might happen for wages and people’s finances and while any economics student will remember the dreaded ‘wage price spiral’, this looks preferable.

In the product market scenario, firms charge us more but don’t fully compensate workers for higher prices, leading real earnings to lag 3.5 per cent, house prices to slip 8 per cent lower and workers to fare worse.

The big question is whether the Bank of England would really raise rates to 3.5 per cent 

Under the labour market one, firms’ profit margins get squeezed but pay goes up and even rises 0.7 per cent in real terms after inflation, and workers do better.

The big question at the centre of these theoretical scenarios is whether the Bank of England would really raise rates to 3.5 per cent, even if inflation spiked to 5.4 per cent.

Such a move would send household and business borrowing costs up substantially and potentially crash the economy. It seems highly unlikely at a time when even a 1 per cent base rate is considered unattainably high by many economists.

But this inflation spike was unforeseen just seven months ago, so maybe it could happen.

There is an alternative scenario though, albeit a wishful thinking one, inflation could vanish away quicker than we think too.

Will the inflation train thundering down the track lead rates to rise? 

Savings rates are on the rise but even if you do find a best buy, don’t get complacent because inflation is running at steam. 

The problem is that while traditional monetary policy theory dictates that should lead to interest rates rising, we haven’t operated under normal conditions since the financial crisis. 

On this podcast, we look at how long it might be before we get back to a normal situation of savings accounts consistently beating inflation. 

Plus why investing attack may be the best form of defence and could you live off grid? 

Press play above or listen at Apple Podcasts, Acast, Spotify and Audioboom or visit our This is Money Podcast page       

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