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What is inflation? What small businesses should know as prices rise

2-minute read

What is inflation? What small businesses should know as prices rise
Sam Bromley

Sam Bromley

26 July 2021

Inflation measures how much prices for goods and services rise over time. In the UK, the Office for National Statistics (ONS) measures inflation for everyday items – this is the Consumer Prices Index (CPI).

What is inflation?

Inflation is a normal feature of the economy. In general, it encourages spending. If prices are expected to rise over time, consumers will purchase goods today rather than waiting.

But inflation can be either too low (meaning that consumers put off spending their money with businesses) or too high (meaning that businesses struggle to set prices, with demand outstripping supply).

What is the current rate of inflation?

The Bank of England lets you check the current rate of inflation. This changes monthly and is based on the aforementioned Consumer Prices Index (CPI), which tracks the prices of everyday items.

The target rate of inflation is 2 per cent. The Bank of England says this is to keep inflation stable and to help “everyone plan for the future”.

The CPI inflation rate for June 2021 was 2.5 per cent, which is 0.5 per cent higher than the government’s target, and up from 2.1 per cent in May 2021.

Why is inflation rising?

As the economy opens up and consumers spend money that they haven’t been able to spend over the last year, demand for certain goods has increased.

The ONS notes that the prices for food, second-hand cars, clothing and footwear, eating and drinking out, and motor fuel have increased in 2021 after falling in 2020. This has contributed to the big jump in inflation we’re seeing now.

Supply shortages for raw materials like timber can also impact prices – we’ve previously examined how surging demand has led to rising costs for materials, as well as labour shortages, in the construction sector.

How does inflation affect businesses?

When prices rise, it doesn’t just affect consumers – businesses end up paying more to buy materials and products. Plus, employees will ask to be paid more to compensate for increasing inflation.

As demand increases, you might already be experiencing problems with your supply chain, as well as labour shortages if you’re looking for staff.

At the moment, it’s not clear whether rising inflation will be ‘transitory’ or long-term. The Guardian reports that Sanjay Raja, a senior economist at Deutsche Bank, expects that CPI will peak at 3.9 per cent in November.

The Bank of England’s deputy governor, Ben Broadbent, believes that “inflation may still prove temporary”, according to The Telegraph.

Depending on your business and the industry it’s in, you might find that it takes time to adjust to the new levels of demand. Bridget Phillipson, the shadow chief secretary to the Treasury, said that businesses need more support to manage the current environment: “The government must do all it can do to keep materials and other supplies moving to prevent shortages, including cutting the unnecessary red tape following the EU-UK agreement, and providing much better training so that we have access to the skills we need here in the UK”.

How is rising inflation affecting your business? Let us know in the comments below.

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