How inflation impacts cost of living

In the UK, the cost of living increased sharply during 2021 and 2022. In October 2022, the annual inflation rate peaked at 11.1%, the highest it had been in 41 years. Since then, the rate has been gradually decreasing, and the Bank of England expects the drop to continue down to 2% by mid-2024.

Inflation and its impact on cost of living has been widely spoken about in recent years as people feel the pinch of their money not going as far as it once did. 

In this blog, we’ll outline what the cost of living crisis is, explore what has caused the high inflation rates, and discuss what you can do to cope with its impact.

What is the cost of living crisis?

The cost of living crisis is defined by a period of time in which the cost of everyday essentials, such as food and bills, increases at a quicker rate than household income. This change results in less  disposable income for individuals and a change in their standard of living. The UK has been in a cost of living crisis since 2021.

Inflation measures how fast prices  have risen year on year and are expressed as a percentage change. The percentage is measured by the Consumer Prices Index (CPI) which is based on cost data compiled by the Office for National Statistics. Many everyday items, including food, fuel, and housing costs, are tracked in the “basket of goods” which is used to calculate CPI inflation.

What has caused high inflation in the UK?

The Bank of England says there have been three large economic shocks which have caused high inflation and price hikes in many essential goods in the UK.

The Covid pandemic

The Covid lockdowns disrupted global supply chains, particularly in Asia and China. When the high demand for products and services returned, many supply chains broke down. There was a shortage of transport shipping in many ports, which led to a rise in transport fuel prices for many manufactured goods. These costs were passed onto the consumers.

Stable supply chains and business operations took a while to return to normal. Staff had been laid off during the pandemic and services had been cut back. This disruption also impacted food supply and the import costs associated with it, on top of higher import costs already in place post-Brexit. In the UK, around 50% of food is imported – much more than other European countries, making our food prices higher.

Russia’s invasion of Ukraine

Unlike the US which produces most of its own gas, or countries like France which generate more power from nuclear plants, the UK imports most of its gas via pipelines from a handful of suppliers, resulting in higher energy prices. These prices crept up more when Russia invaded Ukraine and made the UK’s access to their gas more difficult.

In recent years, the UK government has committed to not importing any gas from Russia. In  March 2023, they published a press release declaring themselves ‘one year free from Russian gas’. This comes as part of the ‘Powering Up Britain’ plan which aims to scale up affordable, clean, homegrown power and build thriving green industries to boost the UK’s energy security and independence and reduce household bills and gas prices long-term.

A shortage of available workers

Workforces in countries across the globe shrank during Covid and most have recovered. However, in the UK there are still around 400,000 people not working, as many young people are opting to study instead of work, the number of over-50s taking early retirement has rapidly risen, and more people are off work with long-term sickness. 

Research also suggests there are fewer workers available due to Brexit, hitting sectors such as transport, hospitality and retail hardest.

When there is a smaller pool of talent to choose from, pay rates rise to attract and retain staff which is another cost which impacts the consumer.

What is the UK inflation rate and how does it affect me?

The UK inflation rate in March 2024 was 3.2% – the lowest rate since September 2021. This is above the Bank of England’s goal of 2%, so it decided not to cut interest rates (which are used to control inflation).

The reason for the drop in the inflation rate was due to the lower cost of some food items in the ONS’ “basket of goods”. However, the Bank of England also considers something called “core inflation” which excludes the price of energy, food, alcohol and tobacco. With these items excluded, core inflation was 4.7% in March.

Interest rates are put up to lower inflation. The theory is that if borrowing is more expensive, people have less to spend and may save more, reducing the demand for goods which slows price rises.

Many individuals feel the effect of the UK inflation rate and the cost of living crisis, as many goods and services are more expensive than they were a few years ago. If the inflation rate continues to decline, the amount of disposable cash individuals have should increase.

How does inflation impact businesses?

The impact inflation has on businesses varies across sectors, though most will feel an impact in some way.

Some of the impacts include:

• Profit margins fluctuating between sectors: Factors such as cost of staff, cost of energy, and supply chain cost increases are affecting different businesses in different ways, causing a discrepancy in profit margins between sectors.
• Reduced purchasing power dampens demand: Price rises result in a fall in sales and an erosion of brand loyalty as many customers seek cheaper alternatives or park non-essential purchases.
• Interest rates affect the cost of borrowing: The raised interest rates also impact businesses, making loans and company credit cards more expensive.
• Employee wellbeing has taken a hit: A growing number of the workforce is off or out of work with long-time sickness, impacted by the cost of living crisis and the stress it brings. Many businesses are also still working out their approach to remote and hybrid working, with employees having differing preferences.

What strategies can individuals use to cope with inflation and the rising cost of living?

There are some strategies you can use if you’re struggling to cope with the current rate of inflation and the rising costs of living. These include:

• Making a budget so you can see where your money is going and see which bills should be prioritised
• See if you’re able to bring in extra cash by checking you’re claiming all the benefits available to you, or having a clear-out and selling old items you no longer use
• Look at ways to reduce your outgoings and see if it’s possible for you to spend less
• Find out if you’re eligible for help through any of the government schemes for low-income households

Interested in learning more about economic growth and how inflation affects the country?

The University of York offers a 100% online MSc Finance Leadership and Management, equipping you with the skills to expertly navigate higher inflation and price increases for businesses and economists, making you a sought-after specialist.

You’ll be able to identify and find efficient solutions for higher prices in things like energy bills and higher wages, and will learn key skills in problem solving and decision making for both short and long-term success.