Inflation - It's Time to Let 2% Go

By Danny Sleeman

As the UK enters a new phase of macroeconomic turbulence, it's time to adjust its inflation target rate.

Currently set at 2%, the UK government's target inflation rate is dwarfed by the current UK inflation rate of 10.1%. Ever since Russia set its belligerent foot on Ukrainian soil on the 24th of February, global markets have suffered from a severe contraction of supply. In August, Russian exports of liquified natural gas to the European Union fell by 70% relative to the previous year, because of Western sanctions and Russian retaliation. Such a steep and perhaps unprecedented drop in LNG supply shook fragile markets and forced gas prices to surge upwards, with UK gas futures reaching 550p by August 2022. And so, with towering and greatly inflated energy costs, many households have been forced into a pool of financial difficulty.

Firms have also been hit. Working costs have massively risen, for example Salford's Lowry Theatre whose winter energy bill is projected to near £1 million. And so, in order to maintain a constant profit margin, an increase in prices is forced in order to offset this rise in costs.

However, Russia is not the only culprit for supply scarcity rarely seen before. Inefficient remnants of the pandemic still remain present in supply chains. Ukraine, with a 10% global wheat market share, reported wheat exports of around 325,000 mt of wheat in the marketing year 2022-23 (June-July) as of July 29, down 53.2% on the year. China's president Xi Jinping's zero-covid strategies has caused relentless factory lockdowns, lessening global supply in many global industries.

Yet, this lower supply has been coupled with robust demand. Savings, greatly increased during the covid 19 pandemic as consumption fell, are being injected back into the economy whilst speculative buying is further keeping demand at bay.

The consequence is inflation of prices. The consumer price index rose 10.1% in the 12 months to September 2022 whilst the retail price index rose by 12.6% in the same time. Optimistic comparisons with the immense inflation in the 1970s have been made, yet to some, inflation does not look like returning to 'stable and low' levels of 2% anytime soon.

The uncertainty over how long the war in Ukraine will last and whether energy supplies from Russia will be further disrupted are two ambiguities which could compound the inflationary effects of higher energy prices past the short-term. At the same time, a combination of structural forces, some caused by the pandemic, could additionally threaten medium-term price stability, whilst a prospective retreat from globalisation and a less trade-intensive, post-Brexit economy might leave UK firms, with greater market shares, in some cases in oligopolies, facing less competition to keep prices down. Furthermore, a failure of labour force participation to recover to pre-pandemic levels (partly due to early-retirements and covid-induced worries) might result in a tighter jobs market with stronger wage pressures and consequent wage push inflation.

However, the greatest factor for this uncertainty over future and long-term inflation could appear to be widespread geopolitical tensions. Russia's invasion has proved a desperate wake-up call to Western leaders over authoritarian and dictatorial regimes in the East. The West's relative powerlessness to take on such regimes has proved clear with economic sanctions and threats providing little sign of threatening oppressive leaders in the short-term.

Maintaining a balance between geopolitical values and trade walks on a thin plank, a plank destined to snap in either direction as the world enters a harsh, unforgiving geopolitical storm, threatening to sway and damage markets further, potentially knocking some off their feet.

And so, the UK's surge in inflation has come at a shock to many citizens and firms, seeing it at a level over 5 times the target. Inflation above the low, hoped-for levels is almost certain to remain for some time, and so, it is necessary to move from economic idealism to pragmatism, adapting upwards from a target of 2%.