Inflation hits worldwide starting from the middle of 2021. It is the rate of increase in prices over a given period of time and measures how much more expensive a set of goods and services has become over a certain period, most commonly a year. As prices grow, fewer goods and services may be purchased with a given amount of money. The general public's cost of living is affected by this loss of purchasing power, which ultimately slows economic growth. The UK and the rest of the world are currently suffering exceptionally high inflation rates, with the Consumer Price Index reaching 8.2% in June 2022, after 30 years of continuously low inflation rates.

 

There are several factors causing high inflation, supply shock is one of them. The Covid-19 pandemic did provide some people with greater disposable income, mostly invested in the stock market, which recovered in the second part of the pandemic after experiencing a quick fall in March 2020. The income was spent on physical things rather than services like restaurants and movies, which were mostly closed during the lockdown. The demand for physical goods was never met as the country which produced most of them was experiencing a harsh pandemic lockdown policy and following a ‘zero-Covid’ approach, causing supply shock. 

 

Besides, the Russia-Ukraine War has also contributed to inflation as disruption to food and other exports from Ukraine, and also the sanctions imposed on exports from Russia. According to the United Nation Food and Agriculture Organization (FAO), the war in Ukraine was mostly responsible for the 17.1% increase in grain prices, which included wheat as well as oats, barley, and corn. Russia and Ukraine account for around 30% and 20% of worldwide wheat and corn exports respectively. Furthermore, wages have not kept pace with rising inflation, resulting in the loss of purchasing power that many people are currently experiencing. The combination of these factors has resulted in a continuous inflationary rise in prices, plunging the world into a cost-of-living crisis.

 

It’s Bank of England (BoE)’s duty to keep the inflation low and stable as low and stable inflation is essential for a healthy economy in which people can plan for the future such that their hard-earned money retains its purchasing power.The main way to achieve this is through adjusting the interest rate which is the amount of money people can obtain through their savings and also the charge they need to pay on their loans and mortgages. During high inflation, increasing interest rates will make borrowing money more expensive and hence encourage people to save. Therefore, they will plan their budget and spend less money overall. When the overall number of people spending on goods and services decrease, the price charged will also tend to increase more slowly and this leads to the lowering of inflation.

 

BoE can influence interest rate in two main ways. The first way is through adjusting the bank rates. A bank rate is the interest rate a nation's central bank charges to its domestic banks to borrow money. It’s the rate charged by the central bank in order to stabilize the economy. Lower bank rates can help to expand the economy by lowering the cost of funds for borrowers, while higher bank rates can help to control inflation when it is higher than desired. Therefore, to meet the inflation target, BoE should judge the amount of people spending given the current interest rates and adjust it according to the situation.

 

The second way is through quantitative easing (QE). Quantitative easing is a form of monetary policy used by central banks to increase the domestic money supply and stimulate economic activity. Usually, it is implemented when interest rates are near zero and economic growth is stalled. Central banks have limited tools, such as interest rate reduction to influence economic growth. Without the ability to lower rates further, central banks must strategically increase the supply of money through executing QE. Central banks buy government bonds or corporate bonds from other financial companies and pension funds and inject bank reserves into the economy. This results in increasing the supply of money and lowering interest rates further, hence providing liquidity to the banking system, allowing banks to lend with easier terms. As a result, this helps to boost spending in the economy and keep inflation at target.