19 Nov 2010 | Capital Hill

Capital Hill on... Inflation 

It erodes the value of your savings and means you have to spend more to maintain your standard of living: inflation – it’s here and is expected to remain high for some time.

The Consumer Prices Index (CPI) measure of inflation remained unchanged in September at 3.1%, according to the Office for National Statistics. In October, it edged up to 3.2%.

It’s been above the Bank of England’s 2% target since December 2009, and the central bank predicted earlier this month (10 November) that inflation would remain above target for the whole of next year.

That’s partly due to a rise in VAT in January from 17.5% to 20% that will hit cash-strapped consumers following their festive spending spree.

VAT is collected by retailers, and they have no choice about whether or not to add it. Some goods are exempt. Essential foods, for example, are zero-rated, while luxury foods are not. (Many biscuits and cakes are deemed necessities, while chocolate-coated biscuits are deemed luxuries – so making small changes to what you put in your trolley could help your wallet).

The rising cost of imports, however, is set to play a greater role in stoking inflation. Mervyn King, the Bank’s Governor, said his expectation that inflation would remain stubbornly high throughout 2011 was largely reflective of “higher import prices, stemming from the recent depreciation of sterling and increases in a range of commodity prices”.

So, inflation is sneaking in through the back door courtesy of our emerging-market trading partners, not least China.

China’s inflation leapt to a 25-month high in October, driven by a jump in food costs, despite government efforts to cool living costs. China’s 4.4% inflation rate – due mostly to a 10.1% increase for food – was far above the official target of 3% and a sharp increase from September’s 3.6%. The World Bank expects China’s inflation to stay as high as 3.3% through next year.

These figures might not seem that high compared to Britain itself. However, China’s statistics fail to paint the true picture more so than other emerging-market nations (like Brazil, Russia and India, where inflation is also significantly high).

Gathering reliable data in a huge country like China is difficult – and it’s clear that the Chinese people think inflation is far higher than figures suggest.

Labour unrest has been sweeping China as workers demand higher salaries. Taiwan’s Hon Hai, the world’s biggest contract electronics manufacturer whose clients include Apple, Dell and Hewlett-Packard, has been wrestling with the fallout from a series of suicides at its Foxconn International Holdings plant in southern China. The company hiked salaries, for workers in the Shenzhen factory, by 30% in June. 85% of the 400,000-strong workforce within the factory also received another wage increase, of about 66%, in October.

So, what does all of this mean for British consumers? On the downside, inflation eats away at purchasing power. Inflation also generally leads to an increase in interest rates, as the central bank tries to bring it under control – bad news for borrowers. However, King has reassured borrowers that there’s little prospect of the base rate being hiked from its historical low of 0.5% as the economy struggles to get back on its feet.

Importing inflation could be good news for Britain’s spiraling rate of unemployment. An increase in the cost of emerging-market production brings inflation to rich-but-sluggish Western economies that have outsourced production to rapidly-expanding economies with lower labour costs, and could subsequently price British workers back into jobs.

Inflation should also be good news for investors in companies that have been able to export throughout the recession and also for gold, traditionally seen as a store of value, though some analysts think the gold price has risen too far too fast.

Finally, a high rate of inflation in September is good news for state benefit claimants, as it sets the rate at which benefits change the following April.

Most benefits are now linked to CPI and will rise by 3.1%, while pensions will increase by the Retail Prices Index, which was higher 4.6%. RPI, which factors in a greater chunk of the cost of housing, is also important for wage negotiations.

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, Media Hill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.