Inflation: now we really have something to worry about

Next clothing retail shop on Oxford Street

Next: expects labour costs to go up

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We’ve been worrying about a sharp rise in inflation for years – now, we finally have something to worry about. UK inflation (using the consumer price index) is now 5.4%, higher than most economists expected (it always is these days) and the highest for nearly 30 years. The retail prices index (RPI) – once the UK’s main measure – is 7.5%. This is nasty news. Living costs are rising fast. The purchasing power of your savings (on which you will be getting less than 1% in interest) is falling fast. And thanks to the fear that interest rates will soon rise a percentage point or two, large parts of the stockmarket are falling.

There is a view (still!) that this is short term. Sure, we are told, 5.4% is bad, and sure, UK inflation could hit 7% (as in the US) and sure, it isn’t vanishing as fast as central banks promised – but it will still be over by April. We aren’t convinced.

Look at the history of this globally, says Julian Brigden of MI2, and you won’t be either. If you have easy fiscal or easy monetary policy you don’t necessarily get inflation. But “fire both barrels… with some ferocity” and the correlation is “nigh on perfect” (Brigden was talking on the MacroVoices podcast and will be on the MoneyWeek podcast next week).

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All the signs are that this time is no different. Both monetary and fiscal policies have been ferocious everywhere for years. The result had been that global demand is booming – in the US, says Brigden, total demand for goods is 34% higher than pre-Covid-19. And as for supply, with demand that high, there is no old-normal to go back to. Even if there was, as long as China is insisting on a zero-Covid strategy (with the rolling lockdowns and human rights violations that brings) how can global supply chains work smoothly?

It won’t be over by Christmas

Here's a hint of what that means: input costs for UK producers rose at a rate of 13.5% in December; output prices rose by 9.3%. On wages, so far pay rises have lagged inflation, partly because workers are out of the bargaining habit. With labour in short supply and inflation everyone’s go-to topic of conversation, that’s going to change – Next has already said it expects labour costs to go up by well over 5% this year.

This will not be over by April – or for that matter by Christmas. This means two things. First, interest rates will rise – enough to scare markets (it doesn’t take much) but not enough to halt inflation (this takes a lot). Second, the government will get very worried (illegal boozing aside, nothing destroys a prime minister’s popularity more than falling living standards) and may start intervening in the market – think price caps, for starters.

We hope they don’t go too far. We might have put up with two years of bossy government, but not many people actually like that – see this week's magazine for the million people leaving America’s bossiest states (California and New York) for its least bossy (Texas and Florida) and for our profile of Guillaume Pousaz, an entrepreneur who started his career in California but is now in London.

Either way, with both central banks and governments stressed and too many markets overpriced, this is no time for financial passivity. Check your portfolio to ensure you own some beneficiaries of inflation (we look at the best defence stocks in this week's magazine). Make the most of what tax breaks there are and pay your taxes on time – the interest rate HMRC charges if you don’t is always going to be higher than the interest you will get on cash you keep.

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