A brief history of inflation

Published: 14 January 2025
Reading time: Two minutes

The UK has just been through a bad spell of inflation but how does it compare to previous periods – and does everyone experience the same level? Handelsbanken UK Economist Daniel Mahoney takes a closer look.

Not every inflationary period is the same.

If we go back a few decades to the 1970s, it was a very different period of inflation compared to more recent times. At points, inflation topped 20%!

One characteristic of 1970s inflation was something called the wage-price spiral problem. That’s where wage increases and price rises feed off each other: as prices go up, employees demand higher wages, which then lead to higher prices. We saw this problem triggered in the 1970s after the culmination of two oil price shocks, macroeconomic stimulus and poor industrial relations. 

Fast forward to the 1980s and we saw inflation come down. There was a big effort by the government at the time to bring down inflation but it came with trade-offs. For example, unemployment rocketed in the early years of the decade as the manufacturing sector declined. 

But inflation did come down to a lower rate, though not to the levels we're used to now. Between 1982 and 1988, inflation was below 5%, but well above 2%, which is the price level increase we’ve been used to for a couple of decades now.

Coming back to the present, we've obviously had a recent inflation spike that took CPI above 11%. This was primarily due to COVID, and Russia’s invasion of Ukraine, and probably exacerbated by loose monetary policy, but you’d have to go all the way back to the late 1980s during the so-called Lawson Boom to see this level of inflation.

The factors behind that were quite different, however. Inflation took off in the summer of 1988 due to financial liberalisation that saw large increases in credit. At the same time it is now commonly understood that sterling being devalued for too long also stoked inflation. These factors set the conditions for the economy overheating and hence you saw an inflation spike. 

So how can governments achieve the “right” level of inflation? You might be surprised to learn that the Bank of England has only been tasked with targeting inflation since 1992. Prior to this, attempts to control inflation included targeting exchange rates and money supply.  

When inflation-targeting began in 1992, monetary policy was still in the hands of politicians but this of course changed when Gordon Brown became Chancellor in 1997 and made the Bank of England independent. So now you have the Bank of England charged with trying to achieve that 2% inflation target. 

Let's just look at one aspect of inflation I think is really interesting – how it’s different depending on your income. Normally when we talk about growth or salaries or unemployment, we're talking about for the economy as a whole.

But groups have their own characteristics and inflation affects different groups in differing ways. For example, take the impact of energy prices. Because low income groups spend a greater proportion of their income on energy, when energy inflation is very high, their effective rates are higher than those of wealthier households.

There are also some geographical discrepancies which are quite interesting as well.

When motor fuel inflation was high, inflation rates for the average Londoner were lower than those outside London because they're less reliant on cars.

Recently however what you've seen is a reverse in that picture and here’s why. CPI inflation doesn't include mortgage interest payments but other data which does include mortgage payments, shows that in more recent times, wealthier households now have a higher effective rate of inflation.

That’s because mortgage rates have gone up quite considerably over the past couple of years and as households have come off fixed rate mortgages, they've begun to pay much higher mortgage interest payments and as a result their effective rates of inflation, if you include that, have gone up significantly.

What does that comparison look like? Well, if you take the second poorest decile, the effective rate of inflation was 1.7% in June 2024, whereas for the second wealthiest decile, the effective rate was 3.3%. 

What’s the outlook for inflation then over 2025? We’re not currently expecting it to hit the magic 2% level for the next couple of years, meaning that the interest rate cutting cycle will likely proceed cautiously. We think interest rates will fall over the course of the next 12 months, but will probably end up between 3.75% and 4% at the end of 2025. 

Watch this space.

Read more: Handelsbanken’s Global Macro Forecast Opens in a new window