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Posted: 2022-06-22 09:15:45

Another major economy has just recorded a large increase in inflation — a key measure of the cost of living.

The UK Consumer Prices Index (CPI) rose by 9.1 per cent in the 12 months to May 2022, up from 9 per cent in April.

UK inflation is now sitting at a 40-year high.

Over the year to May, the CPI rose 7.9 per cent.

Gas, electricity bills a major contributor to inflation in UK

According to the Office for National Statistics, the items in the "basket", or collection of goods and services, that make up the CPI that contributed the most to the overall increase in the index were gas and electricity bills, as well as petrol.

Cars stuck in traffic
In the UK, motor fuel is one of the top contributors to record-high inflation. (Pexels: lifeofpix)

In early June, financial markets plummeted on news US inflation had also soared to a 40-year high.

The hike raised concerns the US Federal Reserve — the equivalent of Australia's Reserve Bank — would need to raise interest rates sharply to cool demand in the economy and bring inflation under control.

Those fears were realised on June 15 when the Federal Reserve increased its benchmark interest rate by the highest amount since 1994.

Unlike in Australia, wages growth in the US is playing a part in the inflation picture.

But the war in Ukraine and supply constraints generated by the pandemic are the biggest culprits.

That is because it is costing businesses more to secure inventory and supplies and they are passing those costs on to customers.

What about Australia?

But Australia is also suffering from these inflation pressures.

Reserve Bank governor Philip Lowe indicated on Tuesday that while much of the lift in inflation was being fuelled by overseas factors like the war in Ukraine and the pandemic, it was increasingly being generated locally.

One of the biggest increases in the cost of living domestically is stemming from the east coast energy crisis.

A large power station with two tall concrete smoke stacks surrounded by transmission lines and a lake.
High energy prices are likely to stick around.(Supplied: AGL)

Aging coal-fired power plants are breaking down, which is making it difficult for energy generators to reliably supply power.

The power producers are scrambling to fix the problems with their power plants, but the parts required to repair them are not always readily available due to shortages.

That has caused havoc in the spot market for wholesale electricity in recent weeks.

The spot market is where energy generators and retailers meet to help determine the price households pay for power by assessing the demand and supply of power available for customers.

The market operator, AEMO, stepped in last week and took control of the market.

Since then the market has stabilised, leading the AEMO to gradually pull back and allow the companies to work out the prices they charge for themselves.

Expect energy bills to increase

The supply of power remains a big issue, however, and that will likely lead to further increases in power bills.

Medium-term solutions, including the capacity mechanism the government is currently working through, could help secure a portion of power supplies but they might put further upwards pressure on energy prices.

The AEMO Reserve Capacity Mechanism recently announced by the federal government will see gas retailers — the ones that appear on your energy bill — paying the power generators to keep gas in reserve for when there is another supply emergency.

Analysts say the retailers will pass that cost on to customers, producing higher energy bills.

Tony Wood from the Grattan Institute
Tony Wood says Australians will be paying more for reliable power. (Supplied: Grattan Institute)

"And, as a consequence, that insurance is something that we as consumers will all pay for because we are going to get reliable power," Grattan Institute energy and climate change program director Tony Wood said.

Treasurer Jim Chalmers warned Australian households the cost of living was set to get worse before it got better.

Australia's inflation rate, or CPI, is currently 5.1 per cent.

The next CPI will be released by the Bureau of Statistics on July 27 this year.

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