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How Does Inflation Impact Businesses?
The Basics

How Does Inflation Impact Businesses?

The Basics is a series exploring the concepts and individuals essential to purposeful business.

5 minute read

16th Aug 2023

In July 2022, you could buy a bottle of olive oil in the UK for £4.51. One year later, that same bottle costs £6.39

All over the news we’re seeing that inflation is stubbornly high – it affects businesses and individuals alike, some more than others. But what exactly is inflation: what causes it, how does it impact businesses and when will the bubble burst?

What is inflation?

Inflation is the increase in price for goods and services over time. It’s measured by how fast prices change over a certain period, which is called the rate of inflation.

It’s easier to think of inflation (or deflation – when prices decrease) as being pulled or pushed by supply and demand. If a good or service is in high demand, a company is pulled to charge higher prices to meet the demand (demand-pull). 

In July 2022, you could buy a bottle of olive oil in the UK for £4.51. One year later, that same bottle costs £6.39.

Or, if the cost of production is increased, a company may be pushed to produce less of these goods and services (cost-push). Inflation occurs when these scenarios are mapped over varied situations to impact a country’s overall economy – as well as any external factors that may influence prices.

Why is inflation so high in 2023?

Most governments set their inflation target at 2% – at this level, it is not inherently a bad thing. It drives economic growth and encourages people to keep on purchasing.

But in the UK, the rate of inflation for July 2023 was 6.8%, while the US saw inflation rate at around 3.2%, and many European countries around 5.5%. In the UK’s case, there has been a perfect storm of factors contributing to its higher inflation rate: 

  • Rising costs of food. With climate change impacting harvests, this has pushed up prices for food and drink – of which the UK is the third largest importer
  • The energy crisis. The cost of energy has risen due to many factors, including the post-pandemic economic rebound and Russia’s invasion of Ukraine
  • Brexit. Tougher migration rules and supply chain issues for trade due to Brexit may be contributing to higher costs
  • Covid. Supply chains were fragmented, and we’re still dealing with the aftermath

However, some countries are currently facing deflation, such as China. They have seen low consumer demand during and even beyond their zero-Covid policy. Some economists have suggested that China’s strict Covid measures have caused businesses and individuals to proceed with caution when it comes to making purchases, even post-lockdown.

How can inflation be lowered?

A country’s government – and its central bank – is responsible for keeping inflation in check. During deflation, the banks stoke the economy by, for example, lowering interest rates to encourage individuals and businesses to take out loans or mortgages. 

But in the case of inflation, central banks may raise interest rates to discourage people from buying, and instead incite investing. As well as this, a government can also impose higher taxes or cut public spending to reduce an individual’s spending power. 

Higher interest rates and taxes are a scary thought, but economist Jonathan Haskel prefers to “lean against the risks of inflation momentum. As difficult as our current circumstances are, embedded inflation would be worse”. This is when inflation becomes an unstoppable, vicious cycle. For example, if a company was to raise their wages in line with inflation, this would raise the cost of goods and services, meaning their customers need higher wages – ad infinitum. The government must intervene before this happens.

“I prefer to lean against the risks of inflation momentum. As difficult as our current circumstances are, embedded inflation would be worse.”

Jonathan Haskel

However, low-income households are often hardest hit by inflation – and the policies that come with it – as they spend a higher proportion of their income on energy and food, while high-income households can adapt more easily by cutting non-essentials and reducing their savings.

How does inflation impact businesses?

Inflation impacts businesses from a supply side: costs of materials and products increase, and it may influence costs associated with trade. Demand side is impacted too: employees might seek higher wages, and these higher costs are transferred to consumers through higher prices.

Very high inflation makes investing and planning difficult for a business; coming up with pricing strategies, managing fixed costs and deciding whether to borrow all gets thrown up into the air as predictions and expectations become arbitrary. 

Some argue that it goes the other way too – that businesses have an impact on inflation through corporate profiteering (see: price gouging, greedflation), but others aren’t as convinced

Individuals, businesses, forecasters and investors are always making predictions for the inflation rate, whether that’s to buy their first house, make corporate investments or simply to choose the less premium cereal option. It may be as much about anticipating what’s to come, as seeing what’s happening right now.