Fighting Inflation and Dancing the Masochism Tango
First published: August 1, 2024
Since 2020, consumer price inflation has been a pressing issue around the world, for individuals and governments alike, and no less so in the US and the UK. It has been driven by a confluence of factors, including supply chain disruptions related to the pandemic, war in Europe, Brexit, and the cost of labor. Everyday expenses, from groceries to housing, fuel, food, housing, and borrowing costs have all been hit hard.
Fuel Prices: The Unseen Catalyst
Fuel prices have been a significant driver of that inflation. In the US, the cost of gasoline surged dramatically in 2021 and 2022. The price per gallon, which averaged around $2.60 in early 2020, peaked at over $5 in mid-2022. Reduced oil production during the pandemic, sharply-increased demand as economies reopened and the geopolitical shockwaves from Russia’s invasion of Ukraine drove up US prices.
Similarly in the UK, petrol prices rose steeply. The average price per liter of unleaded petrol rose from approximately £1.20 in early 2020 to over £1.90 by mid-2022. Britain, which is heavily reliant on imported energy, was acutely affected by disruptions in global oil supplies and the ensuing market volatility.
While not always apparent in the ticket price, the ripple effects of rising fuel costs in the US and UK have spread throughout both economies, affecting production costs and, in turn, pushed up consumer prices.
Groceries: The Rising Cost of the Weekly Shop
The inflationary trend extended into supermarkets, where the price of a typical basket of groceries rose sharply. In the US, consumers experienced significant price hikes in staple items. The price of eggs, around $1.50 per dozen in early 2020, jumped to over $4 by 2023. Similarly, the cost of meat, dairy, and fresh produce saw double-digit percentage increases due to supply chain bottlenecks, labor shortages, and increased transportation costs.
Across the Atlantic, UK shoppers faced a parallel predicament. The cost of a standard weekly grocery basket increased by over 15% between 2020 and 2023. Notably, the price of bread, milk, and vegetables surged, with the price of bread alone rising by 20%. The interplay of Brexit-related supply chain issues, labor market disruptions and the global energy crisis all aggravated the situation, leading to a painful squeeze on household budgets.
Housing: Renting and Homeownership Under Pressure
Housing costs have been another pressure point. In the US, the cost of renting skyrocketed. Cities like New York and San Francisco saw average monthly rents increase by over 20% between 2020 and 2022. The surge was driven by a combination of increased demand for rental properties, as remote work became the norm, and a shortage of affordable housing.
Homeownership costs also escalated. The median price of a home in the US, around $300,000 in 2020, soared to nearly $400,000 by 2023. The rise was fueled by historically low mortgage rates, followed by a rapid increase in interest rates by the US central bank to combat inflation. That cooled the housing market, but as rates stayed high borrowing on home loans became much more expensive.
In the UK, the housing market mirrored these trends. The average rent in London increased by over 15% from 2020 to 2023, driven by a combination of high demand and limited supply. The average house price in the UK also saw a significant rise, climbing from £230,000 in early 2020 to over £280,000 by 2023.
Government Spending: Damned If You Do Spend. Damned If You Don’t
Another element of inflationary pressure in national economies is government spending. Spending normally increases at times when unemployment is high, through higher welfare payments. Inflation is not an automatic consequence, though, given that public spending on those out of work is compensating for wages no longer being paid by employers.
However, the pandemic saw a very large spike in public spending in the US and the UK, as both governments came up with schemes to prevent millions of workers from being laid off. These included generous furlough schemes, business grants, and increased healthcare spending.
In an average year, US government spending fluctuates in a narrow bank between around 36 and 38% of GDP; the measure of all a country’s economic activity. In the pandemic, those two rescue packages helped push that figure to nearly 45% in 2020 and 43% in 2021.
Senior economists, including the former Fed chairman Ben Bernanke in the US and a team from the Office of National Statistics in the UK, have acknowledged the inflationary impact of that spending.
In the 2024 election campaign, Republicans have frequently blamed the inflation on the Biden administration. The reality, though, is that public spending is only one of several components of consumer price inflation, most of which are beyond any one government’s direct control. It’s also true that the largest pandemic support package, at $3.4 trillion dollars, was agreed in 2020, when Trump was president. A second package, agreed after Biden replaced him in the White House in 2021, was valued at $2 trillion dollars.
Borrowing Costs: Dancing the Masochism Tango
As cash and investment flows move so fast across borders in the modern, deregulated era, and global economies are so interconnected, interest rates in different countries often move up and down in lockstep with each other. That’s especially true in the G7 group of the seven most-industrialized countries that includes the UK and the US.
Decisions on base lending rates, and when to change them up or down, is a task legally delegated to the American and British central banks. In the US, that’s the Federal Reserve, or Fed for short. In the UK, it’s the Bank of England.
Between March 2022 and July 2023, the Fed raised its key lending rate 11 times, from virtually zero to 5.25-5.5%. The Bank of England first raised its base lending rate from a low of 0.1% in December 2021, then 13 more times, closely matching the Fed’s timing, to reach the same high point of 5.25% in July 2023.
While the main purpose of the rate hikes was to curb inflation and promote full employment, the increases led immediately to higher mortgage rates. That placed additional financial strain on prospective homebuyers and those with variable-rate mortgages, exacerbating the inflationary impact on household budgets.
Inflation driven principally by forces beyond the control of any one nation is tough to beat. While the rate of price increases had declined towards the target number of 2% per annum in both the US and the UK by the summer of 2024, the two central banks have been fearful of easing rates too soon.
As of July 2024, that high point of 5.25% was where US and UK base rates remained, as the central bankers put caution over optimism that inflation was finally back in its box. The one bright spot for cash-strapped consumers was that most leading economists had been predicting that both the Fed and the Bank of England would start reducing their lending rates, albeit slowly, sometime during the second half of 2024.
And today, with a pinch and a punch, that’s just what occurred. The Old Lady took the lead with a quarter point cut to 5.00%.