Inflation – What it Means to Businesses

Inflation has hit its highest level for nearly 30 years, driven primarily by rising food and energy prices.  It climbed to 5.4% in December 2021, the highest it has been since March 1992 according to the Office for National Statistics (ONS).  

Inflation requires prices to rise across a “basket” of goods and services, those most commonly bought, which is measured by the Consumer Price Index (CPI). When the prices of goods that are essential and impossible to substitute—food and fuel—rise, they can affect inflation by themselves.

The CPI measure of inflation was higher than analysts had predicted.  The cost of raw materials, food, clothes, furniture, hotels and restaurants and second-hand cars have all increased rapidly.  

And the bad news is that it is heading even higher. The Retail Price Index, an inflation measure which is still widely used by government and businesses, is already at an incredible 7.5%. Independent analysts fear the CPI will hit 7% in April 2022 when the energy price cap is raised again.

Inflation decreases the purchasing ability of money as more money is needed to buy the same items. High rates of inflation mean that unless income grows at the same rate, people are worse off. This leads to decreased levels of consumer spending and a reduction in sales for businesses.

And a big concern is that this inflation rate may not be transitory as it is being fuelled by global energy price rises and supply issues rather than demand.  The energy price cap is likely to rise again in the autumn, pushing prices even higher.  This form of inflation is called cost-push inflation and can lead an economy to grind to a halt.  The cost of goods increases but demand for them doesn’t rise correspondingly.

The last major cost-push inflation shock was during the 1970s when OPEC’s embargo of oil to the US and many other countries resulted in the quadrupling of the price of a barrel of oil from $3 to $12.  This caused inflation to rocket to 9% leading to huge economic repercussions.

Stagnant wages

Separate ONS figures issued in January showed that average pay rises are failing to keep up with the rise in the cost of living.

Regular pay, excluding bonuses and adjusted for inflation, fell 1% in November compared with the same month in the previous year.

This means that those on moderate and low incomes are likely to feel the squeeze during 2022 as their wages don’t keep pace with inflation.  An inflation rate of 5% means that a bottle of milk that cost £1 will now be £1.05, so consumers income will be stretched as they won’t be able to buy as much for the money.

Paul Johnson, director at the Institute for Fiscal Studies think tank, said people on low incomes would be particularly hard hit by the rises.

“Everyone, particularly those on modest incomes, has had a long period of wages not really growing any faster than prices over the last decade, so another increase at this point is going to be particularly painful,” he told the BBC.

The effect on businesses

Soaring inflation is a big problem for businesses.  As their bills and the cost of raw materials rise they need to either pass this cost onto the consumer or absorb it.  Stagnant wages mean demand for products is likely to fall so businesses will be reluctant to rise prices by too much.

Increases in the price of fuel and a lack of delivery drivers due to Brexit and the pandemic have pushed up costs for many businesses.  Those in food production and construction have also seen huge hikes in the cost of materials.

If prolonged, this will lead to businesses struggling and failing to make ends meet.  The pandemic has already hit many businesses hard, with everything shutting down for 3 lockdowns, many businesses have struggled to survive.  Rising business failure will, in turn, lead to rising unemployment which is bad for the economy.

An additional pressure is that, to compensate for rising inflation, staff may ask for pay increases, further adding to businesses’ costs.  If businesses pass these costs on, that will lead to further inflation.

High levels of inflation in the UK are also a problem for businesses who export goods.  If inflation levels are lower in other countries, the goods from the UK will be comparatively more expensive, leading to a fall in demand for them.

Inflation causes spending too – if prices are rising quickly there is an incentive to buy now rather than later when the goods will be more expensive.  This in turn results in higher inflation, further decreasing the spending power of money.

Businesses that have been running for less than 30 years will not have faced the difficulties associated with inflation that we are experiencing now so will have no experience in dealing with it.

Alan Jenkins Manager Director of Quadrant2Design and Black Robin Exhibits said “It’s a tough market, first we had to shut down completely during the pandemic, with no government support.  Now we are seeing the costs of raw materials, bills and transport soar.  We are trying our best to absorb these costs and not pass them onto the consumer, but it’s difficult.  If it carries on the costs will have to be passed on.”

What can be done to tackle inflation?

The Bank of England’s typical response to rising inflation is to increase interest rates.  The idea being that if it is costing more to borrow money, people will spend less, and inflation will go down.

However, if inflation is being caused by global problems like the price of fuel, this may not be the answer.

The government could decide to cut taxes on items that are rising the fastest – such as removing VAT from energy bills.  Or it could help those who need it most.  It has been reported that it is considering expanding the Warm Homes discount scheme, for example, which offers those who receive certain benefits the option to apply for a one-off £140 payment.

This however will not help businesses struggling to survive.

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