This page was last updated on 3 November 2023
When will we get back to low inflation?
Prices at the supermarket check-out and other household bills have risen quickly over the last two years. Money doesn’t go as far as it used to. That makes it harder to plan for the future.
Price rises are now slowing down. The prices of some things, such as butter, are already lower than they were a few months ago. But the prices of many others, such as sugar, are still rising.
We expect inflation to continue to slow, and be back to more normal levels by the end of 2025. By normal, we mean that on average, prices are rising by around 2% a year. That’s the target the government has set us.
But many things will still cost more than they did a few years ago. The price of them will just be going up less quickly than it has in recent years.
The Consumer Price Index (CPI) is the measure of inflation often talked about in the news. It tracks how the prices of about 700 things are changing. That basket includes food, household bills and transport.
CPI inflation was just under 7% in September 2023. Here’s what that 7% means. If the basket of the things we talked about was £100, then exactly one year later it would cost £107.
Between 1997, and 2020, CPI inflation was an average of 2%. It began to rise in 2021 and reached a peak of 11% in 2022. It has fallen since then, and we expect it to be down to 2% by the end of 2025.
Inflation in the UK is measured by the Office for National Statistics.
Not all prices move at the same rate. Right now, food prices are going up faster than overall inflation. Even though the price of some items (eg butter) has dropped.
Current inflation rate 4.6%
What is the Bank of England doing to help bring inflation down?
The Bank of England is a public body. We work for the whole of the UK. One of our aims is to make sure money keeps its value. That means working to keep inflation low and stable. The best way we can do that is to use interest rates.
We change interest rates by changing the UK’s base interest rate (Bank Rate). This influences the interest rates that banks and building societies charge their customers for mortgages and other loans. As well as those paid on savings accounts.
Higher interest rates slow inflation down. We know that because the UK (and in many other countries) have used them to do this many times before.
Between December 2021 and August 2023, we raised interest rates a lot.
That has already helped to bring inflation down. But it will take time to work fully. It’s usually thought that changes in interest rates have their maximum effect on inflation after around two years.
The Bank of England is not like other banks. It is the UK’s central bank and it became a fully public body when it was nationalised by the UK government in 1946.
Then, in 1997, the government decided the Bank of England should be given independence. The idea behind that move was a public body can make better, long-term decisions if it is not influenced by day-to-day politics and elections.
The government sets us a target of keeping inflation at 2%. That is the target many other countries have too. It is low enough to keep prices rises small. But high enough to avoid the problem of deflation, which is when overall prices are falling.
In the years since 1997, inflation has at times risen above, and fallen below 2%. But we always brought it back towards that target. On average since 1997, inflation has been close to 2%.
How do higher interest rates bring inflation down?
It may not seem obvious at first, but higher interest rates do bring down inflation.
That’s because they influence how much people spend. And that then changes how shops and other businesses set their prices.
When customers spend less, businesses are less willing and able to raise their prices. They need to attract those customers. When prices don’t go up so quickly, inflation falls.
Interest rates affect spending in a number of ways.
Higher interest rates mean higher payments on many mortgages and loans. So people with those things need to spend more on them and have less to spend on other things.
Higher interest rates also mean savers get more return on their savings. And potential borrowers find it is more expensive to take out a loan. Together these things make it less attractive for consumers and business to spend money.
We’ve increased interest rates a lot over the past two years, and we can see that’s helping to slow inflation down.
There are two main causes of inflation.
One is sometimes called ‘cost-push’ inflation. This can occur when there is a fall in supply of a product or service, which causes its price to rise. For example, after Russia’s invasion of Ukraine, the supply of gas from Russia fell significantly. This in turn meant that price of gas – which is a key source of energy in the UK – rose significantly. That pushed up on inflation both because households consume energy directly (in the form of domestic gas and electricity supplies) and also because higher energy costs make it more expensive for businesses to produce many other goods and services.
The other is referred to as ‘demand-pull’ inflation. This is when there is an increase in the demand for something relative to its supply. For example, if there is too much money in the economy, that can lead to more demand for goods and services than there are available, which pushes up on prices and inflation.
Recent high inflation in the UK has been driven mainly by ‘cost-push’ inflation. That happened first after the supply shortages due to the Covid pandemic and the invasion of Ukraine. And more recently, fewer people available to work after the pandemic is also ‘cost-push’ inflation. It pushes up on wages and businesses costs and prices.
As interest rates work by influencing the amount of spending in the economy, higher interest rates can’t stop these things from happening, nor immediately prevent their effects on inflation.
But regardless of whether inflation is caused by a fall in supply or an increase in demand, interest rates can help reduce the impact on inflation. In particular, by reducing the amount of demand in the economy, they can make it less likely that higher costs lead to higher prices. It can help to reduce any ‘second round’ effects of these shocks – which is when higher prices lead to higher wages, which in turn lead to even higher prices.
Are there any other ways to bring down inflation?
Increasing interest rates is the best way to bring inflation back down. We know that interest rates are an effective tool for managing inflation, because they have been used successfully across many countries and circumstances. They are effective in influencing the amount of spending in the economy, and therefore inflation.
What caused high inflation in the UK?
Three large economic shocks caused high inflation in the UK.
The first was the Covid pandemic. To start with, it led to a big shortage of products and services. That was followed by a sudden huge demand for them. That was the first thing that started to push up prices.
We knew the effects of the pandemic would not last for long. But they were followed by a second big shock. That was Russia’s invasion of Ukraine. It had a huge impact on energy and food prices.
Then, the third shock was a shortage in the number of people available for work in the UK. Thousands of people dropped out of the workforce following the pandemic. That pushed up the cost of hiring people. Employing people is a large part of costs for many businesses. So some of them put up their prices to cover those costs.