Contradicting the popular opinion that inflation is an issue that’s set to stick around for a while yet, an article in the Times this weekend put forward an interesting opposing view - that inflation has already peaked and is likely to be on the way down.
What fascinates me about this is that although economists claim to understand inflation, there are so many different economic issues currently at play, that one has to wonder whether anyone truly has a grasp on when it will fall. The last time the UK was hit by inflation, it took twenty years to get control of it again with it reaching almost 25% in the 1970s then remaining high throughout the 1980s, before finally being subdued by the early 1990s recession.
Current inflation is being caused by a few different factors including the shortage in supply of goods, excess money supply, and short-term supply shocks in the economy. The triggers for this are well-known – Covid-19, Quantitative Easing and the impact of the war in Ukraine on energy supply are widely spoken about. Alongside this, consumer expectation in relation to prices also affects inflation so the credibility of Central Banks is vital.
What’s next for businesses?
So how is inflation going to affect all those businesses that, already hit by multiple shocks, are now tackling prices rising? As prices increase, so too do labour costs (in turn due to general price rises and unusually, a shortage in the labour supply) which puts pressure on business’ margins. If a business has a distinctive competitive advantage, it can raise prices - the Times article mentions McDonalds raising the price of a cheeseburger for the first time in 14 years - but in a competitive market, businesses could easily find themselves caught between the rock of inflation and the hard place of price inflexibility, resulting in weaker businesses potentially failing.
A competitive advantage that would enable a business to increase prices could be well-developed intellectual property creating a barrier to entry for a competitor due to high market entry costs. It maybe there is no easy substitute for the consumer, effectively forcing them to continue to purchase the product despite the higher cost. The business could have a very diverse supplier base that enables it to switch away from those suppliers increasing costs enabling it to minimise increases in its own cost base.
I suspect sectors that will feel it the most are going to be those that can’t flex their prices, or whose products consumers drop first in their quest to save money. “Must-have” goods or services, consumer staples and perhaps high-tech healthcare used by health services may find inflationary times a little easier.
For now, businesses could:
Increase prices (where possible) in line with general market conditions
Ensure that management has a good understanding of the business’ underlying financials, thereby giving the business decision making flexibility
Differentiate products to ensure there is enough demand to provide price flexibility
Automate where possible
History suggests inflation only seems to be brought under control following a recession, which helps to reduce money supply. The Western Central Banks also have the added issue of having to get interest rates back up to levels than mean they are in fact a useable tool for monetary control.
Mervyn King recently commented that we will know that we have inflation under control when we stop talking about it, and I can’t see that happening any time soon.
Whether inflation is going to stabilise or keep rising is a matter of fierce debate across the UK. Last week, prices seemed to be soaring everywhere — from the 20 per cent rise in the cost of a McDonald’s cheeseburger, from 99p to £1.19, to the 11 per cent average rise that FTSE 100 giant Unilever pushed through on its brands, which range from Ben & Jerry’s ice cream to Hellmann’s mayonnaise.