Why has inflation been rising in the UK?
The pound's weakness in recent years coupled with surging commodity prices have driven inflation higher. The VAT increase to 20%, from 17.5%, in January is another factor. "But even after making reasonable assumptions about these influences, inflation has remained elevated and hard to explain," said Allan Monks at JP Morgan.
Bank of England governor Mervyn King expects inflation to hit 5% later this year, far above the Bank's 2% target, before falling back again next year. The Bank has always reiterated that the spike in inflation is temporary, but deputy governor Charles Bean hinted recently that the commodity price boom could force an interest rate rise.
What is stagflation?
You'll be hearing this buzzword more if the economy fails to pull ahead and inflation stays high. A leap in oil prices to above $100 a barrel at a time when Britain's economic recovery remains sluggish has led people to wonder whether history is repeating itself.
In the 1970s, oil price shocks set off soaring inflation and recession in some countries including the US and the UK as governments ramped up interest rates to battle rising prices.
The term was coined in 1965 by the Tory politician Iain Macleod, who became chancellor of the exchequer in 1970 but died shortly after. In a speech to parliament he said: "We now have the worst of both worlds – not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of 'stagflation' situation."
What is the highest inflation we've ever had in Britain?
A historic chart on the Bank of England website shows prices jumped by 36% in 1800 – the highest UK inflation on record in a single year. Britain was at war with France for more than 20 years and the economy couldn't keep pace with the amount of money spent on arms, causing shortages and higher prices for many goods. The 1920s saw a period of deflation – prices fell in almost every year between 1921 and 1933. During the second world war government spending and borrowing rose sharply, pushing up prices by more than 50% over the war years. In the 1970s inflation averaged 13% a year and peaked at 25% in 1975.
And what about inflation globally?
The record of the highest inflation globally was long held by Germany in the Weimar Republic years when money was carted around in wheelbarrows. In December 1923 prices were more than 85,000,000,000% higher than a year earlier and the highest denomination bank notes had a face value of more than 1,000,000,000,000 marks. In post-revolution Russia, inflation reached 60,804,000% that year – some economic historians believe the government deliberately stoked inflation to impoverish the better off.
But after the second world war, Hungary suffered the highest inflation ever recorded. In the peak month of July 1946, prices were doubling in little more than 12 hours. Other countries that have seen sky-high price rises include China during the civil war from 1945 to 1949, Greece in 1944, Argentina in the 1980s and war-ravaged Yugoslavia in 1994.
More recently, Zimbabwe made headlines for soaring inflation, with price rises hitting 66,212% in December 2007 – the highest inflation in the world at that time. The highest denomination bank note had a face value of 10,000,000 Zimbabwe dollars.
By contrast, Japan experienced a long period of deflation during the "lost decade" of the 1990s.
Is high inflation good for anyone?
High inflation raises the cost of living for everyone and erodes the value of people's savings. But equally, it erodes the value of debt over time so people with a lot of debt benefit.
Why is the Bank of England targeting inflation and not economic growth?
The Bank's remit recognises the role of price stability in achieving economic stability more generally, as it explains on its website. Its first priority is to deliver price stability ie low inflation and, subject to that, monetary policy will also seek to support economic and employment growth.
Who sets the inflation target?
The UK government had been targeting inflation since 1992. In 1997, when the new Labour government gave the Bank of England independence to set interest rates, it gave the Bank an inflation target. The target then was an annual rate of 2.5% over a two-year horizon on the old retail prices index measure. In December 2003, chancellor Gordon Brown announced a switch to the consumer prices index arguing that it gave a better picture of spending patterns and brought Britain into line with other countries, and set the new target at 2%. The government's inflation target is announced each year by the chancellor in the budget.
Inflation has been high for a while, so why haven't we been getting more letters from the Bank governor to the chancellor?
If inflation strays from the 2% target by more than 1 percentage point on either side – ie if the annual rate of CPI inflation is more than 3% or less than 1% – the governor of the Bank must write an open letter to the chancellor explaining the reasons, and what the Bank proposes to do to ensure inflation comes back to the target. The governor writes a letter once a quarter rather than every month, which ties in with the Bank's quarterly inflation forecasts.