By: Richard Stone, Chief Executive at The Share Centre.
The significant increase in the headline rate of inflation puts the Bank of England in a difficult position.
On the one hand the Governor will no doubt be relieved at not having to write to the Chancellor at this stage. On the other hand it makes the interest rate decision more finely balanced. The Bank Of England has been holding off raising rates despite growth having been ahead of expectations since the EU Referendum in June 2016 and despite rising inflation in large part due arising from the fall in Sterling. A year on, that fall in Sterling should have largely worked its way through the system and we can see this month inflation pressures coming from areas such as clothing not from typically dollar priced commodities such as oil (driving petrol/diesel costs). The Bank of England has however, seemed keen to support the economy as the outcome of Brexit negotiations remains unclear.
Rising inflation undoubtedly means that a point at which rates will rise is now closer. This may be compounded by the fact that the longer the Bank of England continues to hold off the relatively low rates help cause further weakness in Sterling which in itself may drive yet higher inflation. A rate rise before the end of the year still cannot be ruled out, at the very least if the Bank of England decides it is necessary to signal the turning point in rates and that it will seek to address the rising inflation.
For consumers, the rise in inflation at a time when wage growth remains subdued highlights the reality of falling real wages, reduced real spending power and thus potentially declining living standards. This will add further to political pressure on the Government to end the 1% pay cap on the public sector. Doing so, and potentially therefore fuelling inflation through higher wage growth, will be further cause for the Bank of England to consider a rate rise.
For those trying to save and invest the decline in real wages and the impact on disposable income available for saving or investment is stark. This is self-evident in the current record low savings ratio of less than 2%. This underlines why it is so important for Government to continue to encourage and incentivise savings and investment, particularly for younger savers, through initiatives such as auto-enrolment for workplace pensions and the Lifetime ISA.
This can though only be achieved by a return to real wage growth. This will occur through productivity improvement, which the UK has struggled with, rising wages (which should be paid for from increased productivity) and falling inflation. Rising wages may come with the end of the public sector pay cap, falling inflation may come through increased interest rates and the point at which the Bank of England decides to act is now undoubtedly closer."