Inflation surges as markets bet on an interest rate rise in December

• Watch: Analysis from Business and Economic Editor Joel Hills

The pound in your pocket is buying less. You’ve almost certainly felt it if you’ve filled-up a car in the last few months. You will definitely feel it as the days get shorter and colder and you reach for the thermostat.

The headline rate of inflation reached 4.2% on October - the highest annual rate for 10 years and higher than the Bank of England forecast just two weeks ago. 

Prices are now almost certainty rising at a faster pace than pay and are expected to continue their acceleration for the next six months or so.

Three factors explain the sharp monthly rise in October.

• Gas and electricity bills soared as OFGEM raised its price cap (it will almost certainly do so again April).

• Higher oil prices pushed the price of almost everything higher, most obviously petrol and diesel at the pump.

• And the VAT rate for hotels, pubs and restaurants increased from five per cent to 12.5% and was, in many cases, passed on to customers.

Each of these shocks should be short-lived.

Indeed, while the Bank of England expects inflation to peak at five per cent in April next year, it also believes it will fall back sharply and that there’s a risk it could end up below the Bank’s two per cent in fairly short order.

The United Kingdom’s islands are being hit by global shortages of goods and labour which are slowing growth and pushing up prices.

How is inflation impacting people? Business and Economic Editor Joel Hills reports

We are an open economy. We import most of goods we consume and the past year has seen an extraordinary rise in demand for tradable goods. 

During, and perhaps because of lockdowns around the world, people who couldn’t go out to restaurants spent money on televisions instead. The scale of the change was enormous. Manufacturers in Asia struggled to respond, energy prices took off.

Meanwhile Covid-19 restrictions have continued to disrupt supply chains. Outbreaks closed factories and ports, delayed shipping and turbo-charged shipping container costs. 

Recruitment problems - of which HGV drivers is the most famous - have created further cost and headaches.

These forces have combined to create huge increases in the prices of some goods. A used car in the UK is 23% higher than a year ago. In the US, where a colossal fiscal stimulus put money in people’s pockets, the rate of used car inflation is even higher. Food and drink prices have begun to rise. 

An increasing number of UK manufacturers are reporting higher raw material costs and say they are adjusting the prices they charge accordingly.

The inflation we are experiencing is almost entirely imported and the Bank of England believes that it will fade. However, the Bank is worried about domestic strains in the labour market. A minority of companies are having big problems finding the staff they need and this could push up wages, which in turn could trigger a further round of price rises.

The Bank of England’s job is to keep prices stable and prices are volatile. Its credibility rests on people’s belief that it is serious about pegging inflation to its two per cent target.

The Bank has already said it is preparing to raise interest rates to contain inflation. 

“In terms of the timing of the first Bank Rate rise, Tuesday's strong (post-furlough) employment data and Wednesday's larger-than-expected rise in inflation leaves 16 December as a favourite for a 15 bp rise [from 0.1 to 0.25%],” says Ross Walker.

A move in December - the first of several, if the markets are right - is now priced in again. 

Higher interest rates will not conjure up more HGV drivers or unblock shipping ports. They will curb consumer demand which in turn should reduce the demand for labour which should reduce the upward pressure on wages.

This is not a very pleasant thing to do but, in the face of a supply shock, is really the only lever the Bank can pull.

The Bank will hope that a modest move now will avoid the risk of having to do something more dramatic later, if inflation becomes persistent. 

A stitch in time saves nine. Sometimes you have to cut off a finger to save an arm.