Prices in the UK are rising at a rate of around 10% a year, and the Bank of England forecasts inflation to exceed 13% in the next few weeks due to the domestic energy price cap increase.
Although the consumer price index (CPI) figure for August, at 9.9%, was slightly lower than July's 10.1%, the rate remains close to its highest level in four decades and way above the Bank's 2% target. Looking back over the past 10 years, inflation has been no higher than 3.1% until the current price surge began in mid-2021.
Rapid price changes are harmful to startups and small businesses. Not only can soaring inflation override the figures used in a business plan, but it is also difficult to plan for the future with confidence. As well as higher prices, firms must consider related factors such as rising wage costs and weaker customer demand.
High inflation is a problem for most economies in Europe and North America, and it was initially sparked by the sharp rise in demand that accompanied the end of pandemic measures in 2021. "Think of the global or UK economy as a car: like all cars, economies have an optimal speed of travel, where you are utilising all of your resources perfectly, and everything is in equilibrium," explains Will Hobbs, chief investment officer at Barclays Wealth Management.
"If the car goes too slowly, it stalls – and that's a recession. If it goes too fast relative to its engine capacity, you get smoke coming out of the bonnet, and that's inflation. So inflation is seen by many as a sign you're running the economy too hot relative to its potential growth rate."
It is the job of central banks – the Bank of England in the UK, for example, or the Federal Reserve in the United States – to manage the economy to keep inflation under control. But central bankers' task has been complicated by the changes wrought by Covid-19, Will says.
"Covid had huge impacts – some temporary and some not – in terms of supply chains, but the pandemic also changed attitudes to saving, investing and working, although we don't yet know how or to what extent."
Managing inflation expectations
At the same time, the tools used by central banks to curb inflation – in the main, higher interest rates designed to encourage businesses and households to save rather than invest or spend – are not always effective. As Will points out, central banks can't control oil prices, which have played a significant role in inflation.
"What central banks can do, however, is try to make sure that consumers and businesses believe that 2% inflation is the future," he adds. "At the moment, their message is: we are willing to inflict a huge economic price on all of us, to make sure inflation is not a problem in the medium term."
The problem with individuals and businesses expecting high inflation, Will points out, is that it becomes a self-fulfilling prophecy – for example, workers demand wage rises which, in turn, feed through into a spiral of higher employer costs and further price hikes.
Labour market data, he adds, is therefore likely to be an important indicator as we move forward: the lower the unemployment rate, the more power workers have to demand salary increases. In the UK, the situation is compounded to some extent by changes in the trading relationship with the European Union post-Brexit, while the UK and EU have greater exposure to rising fuel prices caused by Russia's invasion of Ukraine than, say, the US, which has more energy independence.
"For small businesses in the UK, it has been a case of out of the frying pan – the pandemic – and into the fire, in terms of high inflation," Will says. "The keys to survival are likely to be adaptability and resilience. I would also say it is important to remain at the frontier in technological terms: many people say we are in a sort of interregnum between the ICT [information and communication technology] revolution and the advent of artificial intelligence. It is very possible that huge, transformative technological breakthroughs are coming.
"For the time being, however, it is very difficult for businesses to do any planning. With the action we have seen from central banks, I believe that we will be able to bring inflationary pressures under control. But this is likely to be at the cost of a short-term recession."
Focus on resilience
For businesses, therefore, the priority should be on building resilience to these short-term pressures, getting into the right position to take advantage of the opportunities that emerge on the other side – and coming to terms with the fact it is difficult to predict the future with any certainty.
"I would recommend keeping an eye on announcements from the Bank's Monetary Policy Committee: they produce informative and accessible information with regard to inflation," Will says. "There is so much data available in general, and so many experts making pronouncements in the media, it can be quite disorienting. If you're trying to figure out who you should listen to about inflation, a good rule of thumb is to ignore anyone talking confidently about what comes next."
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