Inflation

It affects everything from household budgets and savings to business investment and government policy.

For the UK, managing inflation has been a central and often difficult theme of its economic history, with different eras defined by their unique struggles and policy responses.

The Current Climate: A Precarious Balance

The UK is currently navigating a challenging inflationary environment. As of June 2025, the Consumer Price Index (CPI) stands at 3.6%. While this is a significant improvement from the double-digit peaks seen recently, it remains stubbornly above the Bank of England's official 2% target.

This persistent inflation has profound consequences for the nation's finances, particularly its national debt.

The relationship is multifaceted:

Soaring Borrowing Costs: The Bank of England's primary tool to fight inflation is raising the Bank Rate. This has a direct knock-on effect, making it more expensive for the government to issue new debt. With national debt exceeding 95% of GDP, even small increases in interest rates add Billions to the annual cost of borrowing.

The Index-Linked Trap: A substantial portion of UK government debt consists of "index-linked gilts." The interest payments on these bonds are directly tied to the Retail Price Index (RPI), a measure of inflation that is often higher than CPI. This has created a painful fiscal trap, where high inflation automatically and significantly increases the debt servicing bill, diverting funds from public services.

Pressure on Public Services: Inflation erodes the real-terms value of government department budgets, which are often set in cash terms years in advance. This creates intense pressure for increased spending on public sector pay, pensions, and benefits, further complicating the government's efforts to control borrowing and debt.

A Look Back: Inflation Through UK History

Understanding the present requires looking at the past. The UK's journey with inflation is a story of shifting economic theories, political battles, and global shocks.

The Post-War Consensus: The Primacy of Employment (1950s-1960s)

After WWII, a political consensus (dubbed "Butskellism") emerged, prioritising full employment above all else. Guided by Keynesian economics, governments used fiscal policy to manage demand. Inflation was present but generally low and stable, seen as a necessary trade-off for a strong labour market. However, this "stop-go" cycle of economic management, where the economy was alternately stimulated and cooled, laid the groundwork for future instability.

The Turbulent 1970s: The Great Inflation and National Crisis

The 1970s were a traumatic decade of economic failure. Inflation surged to a peak of over 25% in 1975, triggering a profound crisis of confidence. The key drivers were:

Global Oil Shocks: The 1973 OPEC oil embargo caused energy prices to quadruple, sending a massive cost shock through the entire economy.

The Wage-Price Spiral: Powerful trade unions demanded large wage hikes to protect their members from rising prices. Businesses, in turn, raised their prices to cover the higher wage costs, creating a vicious and self-perpetuating cycle.

Failed Government Policies: Attempts to directly control the spiral through "incomes policies" (government-mandated limits on pay rises) repeatedly failed, leading to widespread industrial action, most notably during the 1978-79 "Winter of Discontent." The crisis became so severe that in 1976, Britain was forced to seek a bailout from the International Monetary Fund (IMF).

The Thatcher Era: The Monetarist Revolution (1980s)

Margaret Thatcher's 1979 election victory heralded a radical and painful break from the past. The government embraced monetarism, an economic theory that posits that inflation is caused by too much money in the economy. The policy response was aggressive:

Punishingly High Interest Rates: The Bank of England hiked interest rates to record levels to choke off demand and reduce the money supply.

Fiscal Austerity and Union Reform: Deep cuts to public spending and landmark legislation to curb the power of trade unions were implemented to break the wage-price spiral.

These policies, while eventually successful in taming inflation, came at a huge social cost, contributing to a deep recession and mass unemployment, particularly in industrial heartlands. Furthermore, the "Lawson Boom" of the late 1980s saw a credit-fuelled surge in growth that led to another inflationary spike, demonstrating that controlling inflation was not a one-time fix.

The "Great Moderation": A New Orthodoxy (1990s-2008)

This period was characterised by remarkable economic stability, with low inflation and steady growth. The defining policy moment came in 1997 when the new Labour government granted the Bank of England operational independence to set interest rates to meet a specific CPI inflation target of 2%. This move was widely praised for depoliticising monetary policy and cementing the credibility of the UK's commitment to price stability.

The Financial Crisis and the Age of Unconventional Policy (2008-2020)

The 2008 global financial crisis shattered the "Great Moderation." Fearing a deflationary depression, the Bank of England slashed interest rates to near-zero and launched a massive programme of Quantitative Easing (QE).

This involved creating digital money to buy government bonds, a policy designed to lower long-term interest rates and stimulate economic activity. While QE likely prevented a worse downturn, critics argue it inflated asset prices and sowed the seeds for the inflationary surge that would follow.

Lessons Learned and Future Challenges

The UK's long and often painful history with inflation provides crucial lessons about the importance of central bank independence, the dangers of wage-price spirals, and the difficult trade-offs between controlling inflation and supporting growth.

Today, the UK faces not only the immediate challenge of returning inflation to its 2% target but also long-term structural pressures. The transition to a Net Zero economy, an ageing population, and an increasingly fragmented global trading system all pose potential inflationary risks. Navigating this complex future will demand a level of policy foresight and credibility that has been hard-won from the lessons of the past.