Inflation’s Second Wind: How Energy Costs Are Heating Up the UK Economy

Inflation is back on the radar, and the culprit is as familiar as a cold winter night: energy costs. With UK inflation rising to 2.3% in October, up from 1.7% in September, households and policymakers alike are grappling with the economic consequences. But what’s driving this resurgence, and what does it mean for the broader economy?

Key Data Summary

• Inflation Rate: Increased to 2.3% in October from 1.7% in September.
• Energy Costs: Price cap rose to £1,717; forecast to rise further in January.
• Core Inflation: Up to 3.3%, exceeding expectations of 3.1%.
• Services Inflation: Rose to 5%, indicating broad price pressures.

Inflation: What’s the Story?

Inflation, the annual rate at which prices rise, is often described as the silent tax. When inflation increases, the real purchasing power of money declines. October’s inflation spike marks a sharp turn after months of declining rates. Central to this rise is a £149 increase in average annual energy bills, bringing the typical household's cost to £1,717 under Ofgem’s price cap. While still lower than previous winters, the increase is particularly burdensome for households already grappling with the cost-of-living crisis with millions continuing to experience and suffer from fuel poverty.

But there’s a twist. Despite energy prices climbing, other factors—like falling ticket prices for live music and a dip in raw material costs—helped soften the blow. It’s a classic tug-of-war in economics: one sector pulling prices up, another pulling them down.

Why Does This Matter?

Inflation doesn’t just erode your wallet; it influences the economy in profound ways:

1. Cost of Living: Higher inflation means everyday essentials—food, energy, and housing—become more expensive. For lower-income households, this can force tough choices between heating and eating. Charities are already warning that many will struggle to keep warm this winter, especially as government support like the £300 winter fuel payment is scaled back for most pensioners.
2. Interest Rates: The Bank of England targets 2% inflation, using interest rates as its primary tool. With inflation exceeding this target, the Bank faces a dilemma. Should it cut rates to stimulate the economy or hold steady to avoid stoking further price rises? October’s uptick in core inflation (excluding volatile food and energy prices) to 3.3% makes rate cuts less likely in the short term.
3. Business Costs and Consumer Spending: Rising costs are squeezing businesses, like Oxford’s restaurant Taste Tibet, which faces higher supply costs and reduced footfall. This creates a vicious cycle: businesses pass on higher costs to consumers, further straining household budgets.

Energy, the Economy, and Policy Responses

Energy costs are a linchpin in this inflationary tale. The price cap, set by Ofgem, limits how much suppliers can charge per unit of energy, but it’s no magic wand. Even with caps in place, global energy markets, geopolitical tensions, and supply chain issues can drive costs higher.

Policymakers are in a tough spot. The government’s decision to make winter fuel payments means-tested has drawn criticism for potentially pushing more pensioners into poverty. Meanwhile, Labour and Liberal Democrat leaders argue that current fiscal policies are exacerbating the problem. Growth-focused strategies, they argue, could alleviate the long-term burden.

So, where do we go from here? Economists expect inflation to hover above the 2% target into 2025, driven by rising energy costs and global trade uncertainties. The Bank of England will tread cautiously, balancing the need to curb inflation with supporting economic growth. For households, the squeeze isn’t over yet, but understanding the mechanics of inflation helps us better navigate its challenges.

Please read: Faisal Islam: The cost-of-living crisis isn't over

Glossary of Key Economics Terms

• Inflation: The rate at which the general level of prices for goods and services rises.
• Core Inflation: Inflation measure excluding volatile food and energy prices.
• Consumer Price Index (CPI): A measure of the average change over time in the prices paid by consumers for goods and services.
• Price Cap: A limit on the amount energy companies can charge per unit of energy.
• Interest Rates: The cost of borrowing money, set by central banks to control inflation.
• Purchasing Power: The value of money in terms of the goods or services it can buy.

Questions to test your understanding:

Question 1: The Energy Price Cap

What does Ofgem’s energy price cap primarily control?

• A. The total energy bill for each household
• B. The amount suppliers can charge per unit of energy
• C. The profits made by energy companies
• D. The percentage increase in energy prices annually

Question 2: What does core inflation exclude from its calculation?

• A. Food and energy prices
• B. Services and retail prices
• C. Transport and housing costs
• D. All government taxes and subsidies

Question 3: Which sector saw a decline in prices, helping to offset October’s inflation rise?

• A. Food prices
• B. Energy services
• C. Live music and theatre tickets
• D. Gas and electricity supply

Answers:

Q1: B

Q2: A

Q3: C