What causes inflation?
Rampant inflation is the harsh reality of our time. It chips away at our purchasing power, testing the resilience of workers and businesses alike. Virtually all global economies are impacted.
With UK inflation remaining robust, it is imperative to understand what causes inflation and how to manage it, in order to protect our wealth and businesses.
1. Inflation is defined as “a rise in prices across an economy”, and it happens when demand exceeds supply. This can happen for various reasons, such as supply shocks (like the Russo-Ukrainian war and the pandemic) which disrupt production.
2. When there’s more money in circulation, people tend to spend more which drives up prices. However, despite Milton Friedman’s incorrect claim that “inflation is always and everywhere a monetary phenomenon”, expectations also play a critical role!
3. Goldman Sachs recently suggested ways to protect our wealth and businesses during times of high inflation. For example, investors could take a longer term perspective and “invest in real assets such as real estate and infrastructure”, especially where “contracts are linked to inflation”. Investing in technology companies may also represent a good opportunity currently, where low valuations don’t reflect company fundamentals.
Lastly, whilst the OBR forecasts that UK inflation will peak in 2023 and drop to 4% by the end of the year, we still need to be cautious. Tight labour markets are still placing pressure on wages and services pricing, and we could experience further supply chain shocks in commodities and/or sharp currency movements.
Like Jeremy Hunt recently remarked, things may get worse before they get better. Here’s hoping…
