The UK’s cost-of-living crisis is taking a firmer grip, with the UK public and businesses entering the next phase of the crisis as the energy price cap increases for millions of UK households and businesses, national insurance tax contributions increase and services firms with price inflation clauses pegged to the Consumer Price Index or Retail Price Index apply pricing adjustments (e.g. mobile service providers). The Consumer Price Index (CPI) rose by 5.5% in the 12 months to January 2022, up from 5.4% to December 2021. With additional upside risk forecasted for the rest of 2022 and into early 2023, the CPI inflation rate hit 6.2% in March, just shy of the 7.1% last seen in March 1992 (30 years ago). This milestone will undoubtedly be beaten by the Summer as further price rises are expected across food, energy, and natural resource commodities in the coming months.

The Bank of England’s latest inflation forecast indicates inflation reaching 10% towards the end of 2022, with the Governor of the Bank of England already warning the UK’s Chancellor of the Exchequer (the “Chancellor”) of higher inflation beyond the Bank’s February forecast in response to higher commodity prices following Russia’s invasion of Ukraine. With additional upside risks to inflation caused by escalating supply shortages impacting electronics and large goods industries, global trade tensions and the effect of western sanctions on Russia, inflation could peak above the current forecast of 10% by the end of the year. 

The cost-of-living crisis is expected to put hundreds of thousands of British families into poverty, as price rises accelerate across day-to-day living expenses. The cost-of-living crisis will significantly escalate the social and financial risk facing people up and down the country. As price rises take effect, the risk of social unrest is escalating at a rapid pace, as hardworking people struggle to make ends meet and are forced to make critical decisions, such as whether to heat their homes or provide a meal for their children. We should not underestimate the consequences of the social and financial risk facing millions of families as persistent higher inflation eats into the standards and quality of living.

The Chancellor’s Spring Statement to Parliament proved largely underwhelming for people hoping the Chancellor would announce substantial financial support measures to offset the effects of significant higher above-target inflation. The UK government has since stated its willingness to do more in the future as the escalating effects of the cost-of-living crisis become clearer. The extent of the government’s willingness remains unclear, with some people criticising the government for not seeing the cost-of-living crisis as a crisis event.

One must ask how and why the Bank of England’s inflation forecasts continue to be so inaccurate, with the Bank’s latest inflation report understating the risks of higher inflation, leading to the Governor of the Bank of England warning the UK Chancellor in a letter dated the 17th of March 2022 of higher inflation than forecasted in the Bank’s February inflation report.

In February 2022, I issued a letter to the UK Chancellor, putting forward arguments suggesting the Bank of England has walked the UK public and businesses into a cost-of-survival crisis, by failing to effectively model changes to the functioning of the UK’s economy into inflation forecasts. 

As the UK and global economy adjust to a prolonged period of unprecedented global change led by the onset of the technology revolution, the UK government’s post-Brexit economic policy, the balancing of global geopolitics and major industrial transitions (e.g., the “green” transition), the Bank of England must update its economic models to incorporate these trends and improve inflation forecasts to promote more proactive monetary policy and better control inflation. Failing to do so could result in the UK public and businesses facing a more frequent pattern of higher inflation in the future as these economic fundamentals take a firmer grip.

In my latest letter to the UK Chancellor, I urge the Chancellor to launch an independent investigation into the functioning of the Bank of England’s Monetary Policy Committee (the “Committee”) to independently assess the effectiveness of the Committee’s forecasting models to predict future inflation risks accurately and reliably against a changing set of economic fundamentals.

Underpinning my advice to and request of the Chancellor is a detailed paper
I published in 2020 into the effect of new and changing markets on historical
forecasting models. The paper entitled New Markets, New Models, can be found here.

A copy of the Chancellor’s response will be published on Risk Panorama.