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Inflation is back, but Sunak is intent on taking money out of pockets

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Prices are climbing in the shops and consumers face an autumn crunch. Official figures show inflation rose at the fastest rate in a decade in August, as the impact of Covid-19 and Brexit drives up the cost of living.

Surpassing the forecasts of City economists, the 1.2 percentage point increase in the consumer price index was the largest since January 1997, the year Gordon Brown would later handthe Bank of England independence to manage inflation. At 3.2%, the CPI is now the highest since March 2012.

Questions will be asked about how Threadneedle Street will respond. But there is a tougher challenge for the Treasury: is this really the right time to take more money out of people’s pockets?

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Despite soaring living costs, that looks like the plan, with the biggest ever overnight cut in social security planned for universal credit, a public sector pay freeze and rise in national insurance contributions.

September is the month when NHS workers will get an extra dollop of cash in their pay packets from the government’s pay deal announced in July, backdated to April. While this will help, the pay cheques also arrive as the 3% wage increase is erased by the rising cost of living.

Combined with the end of furlough this month, the government plans will take a considerable slug of demand out of an already slowing economy. The build back better strategy could soon become muddle through more of the same, in a reboot of the 2010s when recovery from the financial crisis was choked-off by austerity hitting households’ spending power.

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Shortages of workers and materials have weighed on activity in recent months and brought growth close to stalling. With the Delta variant threatening a difficult winter ahead, experts warn the UK economy is heading for a rough patch.

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Alarm bells ought to be ringing in the Treasury, yet Rishi Sunak appears sanguine. There are reasons why the chancellor can take some comfort. The Bank of England expects inflation to fall back from a peak close to 4% this year, as temporary factors recede.

With CPI based on the annual change in the price of basket of goods and services, much of the recent increase reflects a sharp snap back from a record slump last year. Accordingly, record price rises in the last 12 months would need to keep setting new records in the next 12, and that’s unlikely.

The biggest factor this August was the chancellor’s ““eat out to help out” scheme a year earlier, when Sunak’s half-price dishes temporarily slashed the cost of living. The Office for National Statistics said inflation should have been at least 0.4 percentage points lower as a result.

Yet while the chancellor won plaudits for helping households’ finances last year, pressure is mounting for the opposite reason.

Business leaders are warning that supply disruption could last at least two years and some changes will prove permanent, particularly from Brexit erecting tougher trade barriers and reducing the supply of EU workers in Britain.

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Supply chain disruption is at its worst since the 1970s and companies are reporting a record number of job vacancies. Shipping costs have quadrupled, the cost of raw materials for manufacturers has surged, and global energy prices have hit record highs.

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With growth hitting a soft patch this autumn, economists warn there is a whiff of stagflation in the air. It will be an uncomfortable period for the Treasury and the Bank of England to weather, yet tougher still for hard-pressed British households.