On Tuesday 18th January the UK Office for National Statistics (an independent agency) reported Core Price Index (CPI) and Retail Price Index (RPI) to the markets. The figure that caught the eye was the CPI (year on year) figure showing that the current rate of inflation for the UK is 3.7% when the expected level was 3.4%.
What does this mean? The short answer is that inflation for UK citizens is currently 3.7% meaning that every year it is costing 3.7% more for you to buy your core essential goods. As the Government had publicly stated their intention of maintaining a 2% rate of inflation and the current rate almost double this, it appears likely the government will adopt a strategy to tackle this sooner rather than later.
Why has inflation risen so much? As with many things when there is an increase in demand the price will rise and with Asia continuing to boom (Chinese growth is still running at over 9%) the demand for commodities in Asia needed to fuel this growth coal, steel, copper, oil and gas have all risen by sizable percentages. There have also been several other contributing factors such as the extreme global weather conditions that have affected crops, specifically wheat harvests which are down 15% on a 5 year rolling average. Increase in Taxation in an effort to reduce the countries deficit has also raised people's annual costs. If taken in isolation, any one of these aspects would not be enough to create an untenable inflation rate but when taken together, they leave the government assessing how best to tackle the situation.
When Inflation rises there are several obvious consequences, the cost of living rises and people will have less expendable cash. As the UK base rate is currently 0.5%, anyone who has savings will be losing 3.2% value (dependant on what rate they can get from their bank) per year. This is particularly bad news for the ever growing number of retired who are dependant on their pensions and savings. Historically the most common tactic used by central governments to combat this has been to raise the Interest Base Rate. A higher Interest Base Rate will encourage people to save money rather than spend it and the subsequent decrease in consumer spending will result in a lack of demand causing prices to gradually decrease.
Like dominos all of the above aspects will have a catalytical effect on the next. Meaning that, following the announcement by the ONS on Tuesday the currency markets have begun to factor in the Bank of England raising the base rate. With cash always trying to find it's way to the home that will give it the greatest returns we have seen Sterling buying and it's relative strength against other currencies increase. If the inflation rate remains at these high levels or were to go higher, the pressure on the Bank of England would almost dictate that they had to raise the base rate. Until such time that these pressures appear in any other major currency countries finding a home in Sterling will continue to be attractive to the currency markets.