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Keep inflation on your radar

By Andrew Harding, FCMA, CGMA, Chief Executive — MA, Association of International Certified Professional Accountants

The U.K.’s annual inflation rate climbed over the Bank of England’s target for the first time in almost two years, reaching 2.1% in May 2021. This has pushed consumer prices to rise quicker than initially expected as lockdown restrictions were eased and shops reopened.  

It is fuelling concerns that the inflation rate will continue to climb well beyond the 2% target for a sustained period of time, and create additional pressures on our damaged economy and businesses that already struggle to survive.

How much should we worry about inflation?

Spending bottlenecks

With the easing of restrictions set to continue in the next few months and rapid progress being made with the COVID-19 vaccine rollout in the U.K., demand for goods and services will inevitably soar and push consumer prices up. This surge in inflation will also be fuelled by households spending excess savings accumulated in the past 15 months, especially as prices for air travel and holiday accommodation leap in response to higher consumer demand.

Commodity boom

In recent months, the prices of raw materials, commodities and shipping costs have risen, leading to a surge in producer prices. We should also watch out for imported inflation coming through our global supply chains. Recent pandemic-induced disruptions — such as increased costs for components, freight and labour, and shipping delays — are adding to existing producer pressures. These increases will cut into profit margins and eventually push U.K. consumer prices to rise. But there’s little evidence that this is currently happening. In anticipation of a global recovery, many are also watching oil prices, responsible for pushing up the price of petrol, diesel and plastics, which are fundamental to many products.

The impact of support measures

According to the National Audit Office (NAO), the U.K. Government expects to spend £372 billion on COVID-19-related measures as of May 2021. In addition, the Bank of England helped reduce the cost of loans and mortgages for businesses and households by cutting interest rates and injecting money directly into the economy, known as quantitative easing. This was necessary to prevent mass business closures and unemployment, and the economy from imploding.

However, the twin policy of creating new money and additional public borrowing to pay for COVID-19 support measures could also lead to price increases in the coming months. Some of that extra money has been spent in the economy, but consumers and businesses are still holding onto some of that money, waiting for restrictions to be lifted. There’s a risk that this pent-up money could eventually create increased inflationary pressures if supply is lagging behind expanding demand.

Keep an eye on inflation

Some measures can be taken, such as raising interest rates, to prevent inflation from getting out of control and hampering the U.K.’s post-pandemic recovery. However, there is still uncertainty, and we cannot rule out further COVID-19 restrictions later this year. That’s why businesses must future-proof their organisations and become resilient by design now.

Businesses fail not only because they are unprofitable in the short term, but because they suddenly run out of cash.  This can happen for a variety of reasons, including poor working capital management (such as inventory obsolescence or bad debts), the loss of funding (such as bank loans or bond redemptions), increased cost of capital (such as higher interest rates) or the need to maintain healthy dividends. For businesses facing inflationary pressures, cash reserves can serve as a buffer. Cash makes a business resilient.

As business leaders look forward to the next 12 months, they should ask themselves some key questions:

  • When planning for the future, have you run different scenarios for your business?
  • Have you run scenarios that include your business operating in adverse conditions?
  • Can your business survive such shocks?
  • If your business experiences hardship, how can it continue to generate a healthy free cash flow?

With the support of their finance teams, businesses must start planning for their future now to cope with the uncertainties of tomorrow’s new business environment.