Opinion: However temporary, inflation hurts

Young female staff giving parcel and coffee to customer at takeaway counter in coffee shop

Arabica coffee beans reached a four-year high in May, which will have an impact upon cafes and restaurants across the land. - Credit: Getty Images/iStockphoto

Whenever governments or quasi- government bodies issue statements pronouncing that some measure, policy or forecast will only be ‘temporary’ or represent little more than a short-term, ‘blip’, citizens should be very concerned.

Take income tax. Introduced in 1799 by William Pitt the Younger, this supposedly temporary measure was created explicitly to fund the war against Napoleon.

The war ended in 1815 and while the government wanted to retain the tax to help reduce soaring national debt, there was enormous public opposition to it. The tax was denounced as 'repugnant' at a public meeting in Manchester and almost 400 petitions deriding its retention were submitted to Parliament.

Though it was suspended in 1816, income tax survives 222 years after its introduction. Moreover, although the original rate of tax was 2.5%; today’s top rate is 45%.

The UK is not the only nation affected by so-called temporary actions. Prior to World War I, Bismarck introduced a temporary tax on Champagne, ostensibly to fund the construction of Germany’s Grand Sea Fleet. Today, Bismarck’s fleet lies rusting on the seabed, but Germany still taxes Champagne.

Earlier this week, the Bank of England forecast a ‘temporary’ rise in inflation beyond 3% as Britain’s post-Covid-19 economic recovery gathers pace.

Woman in mask against virus is in building materials store she holds cart on which huge sheet of ply

Through inflation, lumber prices have soared to 299% above their 20-year average - Credit: Getty Images/iStockphoto

Officials believe the official measure of inflation will surge well above the bank’s longer-term target of 2%, eventually exceeding 3% as the nation recovers more strongly from lockdown than many commentators had originally expected.

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As anyone who has recently attempted to book a staycation will attest, holiday prices have soared. Inflation is often described as ‘the consequence of too much money chasing too few goods’ although it could also be deemed the savings-eroding upshot of rising demand exceeding supply.

Nor are price increases limited to the UK.

A combination of drought in Brazil and protests in Colombia which delayed shipments resulted in the price of Arabica coffee beans reaching a four-year high in May. The knock-on effect will have an impact upon cafes and restaurants across the land.

Meanwhile, unseasonably bad weather in Australia has pushed up the price of iron ore, the price of which reached a record high last month, while the shortage of timber has resulted in many small builders delaying projects until supplies increase: in the meantime, lumber prices have soared to 299% above their 20-year average.

Passengers commercial airplane flying above clouds, front view. Concept of fast modern travel

Holiday prices have soared - Credit: Getty Images/iStockphoto

Rising prices and the expectation of further increases has not deterred British consumers. Retail sales leapt by almost 17% between January and April (again reaching a record high) and economists anticipate that total consumer spending will grow by 4.6% this year.

Why is this happening? The short answer is lockdown. For almost a year, consumer bank deposits and savings grew at unprecedented rates until the money started burning a hole in their pockets and they decided as a nation to start splashing the cash. Unconcerned with rising prices, many folks felt that they deserved a treat, an understandable reaction to prolonged restrictions.

Whether they’re enjoying a midweek restaurant meal, having a new kitchen fitted or booking a staycation, rather than take their custom elsewhere, within reason consumers are prepared to pay the new going rate. Similarly, if workers expect inflation to continue rising (and they should), we should assume they’ll demand pay rises too.

Moreover, unemployment appears to be tumbling. The Bank of England noted this week that “Vacancies have risen above pre-Covid levels and there are increasing signs of recruitment difficulties for some businesses and in some locations and sectors.”

Rising inflation, coupled with historically low interest rates, has a damaging impact upon cash savers because once the level of inflation exceeds interest rates, savers’ real returns turn negative.

Of course, this has been the case for more than a decade, but inflationary pressures have not been as acute over that period. Now they are, which explains why millions of people are searching for an income-producing home for their savings. Index-linked savings accounts remain popular, as does investment property as well as stocks and shares.

The fall of coronavirus exchanges . forex trading graph and candlestick chart suitable for financial

Mindful of inflation’s corrosive impact upon their money, many savers have started transferring longer term savings into shares - Credit: Getty Images/iStockphoto

For people saving for retirement, rising inflation erodes the purchasing power of their pension pot; the situation is worse for retirees on a fixed annuity pension income as the future buying power of their income suffers as prices rise.

Mindful of inflation’s corrosive impact upon their money, many savers have started transferring longer term savings into shares, while remaining conscious of the potential volatility to which they’re exposing themselves.

Others are buying gold or boosting their pension pots and enjoying (for now, at least) the generous tax break such action affords. Cash ISAs are being replaced by stocks and shares versions of the same product as the search for inflation protection continues. Yet before doing anything, perhaps the most effective response to inflation’s dark spectre is to take professional investment advice.


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