What does the potential 18% inflation actually mean?

Global events, including the war in Ukraine and the Russian sanctions that followed, have led to steep increases in the price of oil and gas. Soaring business and household energy bills, high fuel costs, and rapidly increasing food prices are combining to push inflation levels ever higher.

So with the rate of consumer price inflation forecast to rise to 18.6 per cent in January 2023, what does it actually mean for businesses and consumers? Will the effects be palpable, or have little day-to-day impact for business owners and individuals?

How does high inflation affect businesses?

High inflation negatively impacts businesses in a variety of ways. From increased trading costs to supply chain disruptions and reduced profitability, the outlook for some businesses is stark.

But does high inflation affect all businesses in the same way?

Does rising inflation impact all businesses?

The impact of high inflation isn’t the same for all businesses. For those able to absorb some or all of the costs, or that can pass them on to consumers without losing trade, the projected 18 per cent inflation rate may not represent such a significant danger.

Larger corporations are typically more able to withstand economic pressures due to their size and stronger financial foundation. Exposure to the risks of high inflation can also be determined by the industry in which a business operates.

For example, businesses reliant on consumer discretionary spending, such as restaurants and entertainment venues, face a risk of decline if inflation continues to rise. So how might businesses be affected in real terms by the predicted inflation rate?

Disruption to supply chains

If supply chain members experience their own difficulties due to the high inflation rates it could disrupt the entire chain, causing longer lead times, higher prices, production problems, and ultimately the loss of custom for businesses sourcing raw materials.

Higher wage costs

When inflation rises employees also suffer the effects of higher prices and may demand wage rises to cover their increased cost of living. Businesses could then experience low retention rates if employees consider changing jobs to access better pay.

Higher prices/loss of customers

If businesses are forced to increase their costs due to the inflationary effect, they risk losing the customers who cannot afford higher prices. Consumers are also likely to be struggling financially, and the sudden drop in turnover can be difficult for a business to deal with quickly.  

Enforced cost cutting

Higher operational costs may lead business owners to assess their outgoings as a matter of priority. Streamlining variable costs makes the business ‘leaner’ and better able to weather the storms of high inflation. Essentially, it preserves positive cash flows but also negatively affects plans for growth.

Reduced profitability

A particularly disheartening consequence of high inflation is reduced profitability, particularly for businesses that were in a strong position during times of lower inflation. The profit margin and bottom line for a business affected by inflation slowly depletes as inflationary forces take effect. 

Lower borrowing capacity

Higher interest rates typically accompany high inflation, meaning increased costs for borrowers. This could mean that businesses forced to take on borrowing during Covid-19 may already be highly leveraged, and unable to afford further borrowing costs.

Low growth

A rapidly increasing inflation rate can disrupt plans for growth if the business becomes financially unstable. Business owners may be reluctant to invest in their business under such circumstances, or simply be unable to do so due to lack of cash.

Growth can also be affected for businesses trading worldwide. If the UK’s rate of inflation is higher than the countries they trade with, demand for products may fall due to the additional expense.

What does 18% inflation mean for households?

When inflation rises and wages don’t keep pace, consumer spending power is reduced as the value of their money has effectively lowered. Unsurprisingly, a fall in consumer spending also means businesses suffer as a result.

Households face significant difficulties ahead, however, and the relentless pressure on their finances may become unmanageable over time.

Lower standards of living

It’s impossible to retain the same standard of living if priority bills and the price of essential everyday items significantly increase, and wages remain at the same level or below the rate of inflation. Soaring energy, fuel, and food costs, and increases in the Bank of England interest rate, all combine to stress household finances.

Greater potential for debt and bankruptcy

The increase in energy costs alone is unprecedented, and could force individuals who were previously financially stable into unmanageable debt. Relentless demands on household income may mean bankruptcy is the only way out for some.

Job loss or job change

As businesses struggle to deal with the effects of high inflation they may be forced to close down, leaving employees reliant on state benefits and less able to deal with inflationary costs unless they can find alternative employment. 

No discretionary spending

Non-essential spending may fall – on holidays abroad, new cars, and meals out, for example. For people struggling to feed their families, keep a roof over their head, or heat their homes, foreign holidays or meals out will simply be unrealistic.

Significant challenges lie ahead for businesses exposed to the projected high inflation levels. Consumers face an equally daunting future, and unfortunately, the effects of potential 18 per cent inflation are likely to be tangible on a daily basis.

By Keith Tully of Real Business Rescue