The rise in the annual inflation rate to 1% last month is just the start. The cost of living in Britain is certain to increase noticeably over the next 12 months and likely to peak at about 3%, perhaps even a bit higher.

A bit of perspective is needed. By Britain’s recent standards, inflation is still low. Harold Wilson could only dream of 1% inflation when prices were shooting up at an annual rate of almost 26% in 1975. Despite her best efforts, Margaret Thatcher never managed to drive inflation down to its current level.

This is a different age. Globalisation, de-unionisation and weak growth have led to the death of inflation. For the past two or three years, the big fear for central banks has been deflation rather than inflation.

Britain no longer has that problem. The sharp fall in the value of the pound since the referendum on 23 June has banished any fear of deflation for several years to come, because anything that is imported – from French wine to Apple iPhones – costs more.



The upward movement in September from 0.6% in the year to August did not have much to do with the slide in the pound’s value, but make no mistake, the fall in sterling will eventually feed through into higher prices in the shops and at petrol stations.

Two factors explain the inflation increase. The first is that some prices are going up. Clothing was dearer, motorists noticed that petrol and diesel were a bit more expensive. Hotel bills were also higher, which is mainly explained by the above inflation increase in the minimum wage in April. The higher salary costs that resulted from the introduction of the “national living wage” are being passed on to customers.

The second reason for the upward movement is that prices were falling in September 2015, due to tumbling global energy costs. That has since ceased to flatter the annual inflation rate.

There were further sharp falls in energy prices during the final quarter of last year, so had sterling remained unchanged on the foreign exchanges in recent weeks, there would still have been a pickup in the annual inflation rate.

The fall in the pound to its lowest level against the dollar since the mid-1980s will accelerate this process. While inflation is still comfortably below the government’s 2% target, it won’t be for long. Expect the annual cost of living increase to reach 2% by early 2017 and 3% by next summer.

Competition in the high street could spare consumers from some of the effects of the weak pound. But if businesses find they are operating with lower profit margins, they will seek to save money by tightly controlling wages. One way or another, living standards are going to be squeezed.

What’s more, government welfare changes mean those on the lowest incomes will be especially hard hit, because George Osborne’s July 2015 budget froze non-pensioner benefits in cash terms for the duration of the current parliament. The Institute for Fiscal Studies estimates that 11.5 million benefit claimants would have been £260 a year worse off by 2019-20 before sterling’s slide. Higher inflation has pushed that figure to £360.

Will higher inflation lead to the Bank of England raising interest rates? Almost certainly not. Threadneedle Street has already said it is prepared to accept a temporary overshoot of the 2% inflation target, rather than risk damaging the economy’s growth prospects. Only if higher inflation looks to be becoming embedded will the Bank move. For the moment, that does not appear to be much of a risk.

