What does 2.6% inflation mean for my money?

So what causes prices to rise more sharply sometimes and then for these increases to slow at other times? There are a huge number of factors that drive inflation, and it can seem a little complicated, as many of these reasons are interlinked, but broadly speaking, inflation tends to rise more sharply when:

• Business costs rise – known in the economic world as ‘Cost push’ inflation, this is where the cost of doing business goes up and this increase is passed on to the consumer. The cause of the rise in costs could be for a wide array of reasons, including:

  • Raw materials have become more expensive – If an item has become less readily available, or the country the item is being exported from is becoming more developed, they may charge more for their materials.

  • Workers demanding more money for their work – This can happen if a group of employees has organised themselves to demand higher wages, or where there is more demand for certain roles than there are people to fill them. We are currently seeing this in the UK with a shortage of HGV drivers, which has seen an increase in salary offers and packages to attract more people into the roles.

  • Increase in property prices – As the demand for appropriate working locations goes up, so do the prices businesses have to pay to get them.
    
    

• There is greater demand for goods and services than there is supply – also known as ‘Demand’ inflation, as the demand for a certain item or service goes up, so does the price, as the amount of that item or service that is available is limited. Governments are able to stimulate this situation by offering tax breaks or reducing the amount of tax you pay, which means people have more disposable income and can inject more money into the economy, but as people have more money to spend, prices will also tend to increase, creating demand inflation.
  
  

• The exchange rate changes – Much of the UK economy is based on imports and exports of goods to other countries, so when the pound weakens against other currencies, we will have to spend more to buy the same things as before.
  
  

• More money is created electronically – When the economy is in need of support, as it was during the pandemic, the Bank of England can pump money into it via a process known as quantitative easing. This essentially involves creating new money electronically which is then used to purchase government bonds. This pushes up the price of bonds, which in turn means that the bond yield, or ‘interest rate’ that holders of these bonds get, goes down. Lower interest rates on bonds affect rates on loans for businesses, which become cheaper. This helps boost spending and pushes up inflation.