Inflation is not a new phenomenon that consumers, businesses, banks or e-commerce giants have had to deal with. The first time the term was used to describe an inflation of a currency was in Latin in 1838; after which it became a term and a practice often used and implemented by governments. To the consumer, hearing that inflation is increasing is simply a sound call that their cost of living will increase. To businesses and e-commerce players, it’s a sign that their overhead costs and the prices of their product may have to climb the ladder too. It’s safe to say that inflation isn’t the favourite of most - consumers and businesses alike.
Fast-forward to 2022 and many countries in Europe, Asia and the US are experiencing some of the highest inflation levels in decades as a culminating effect of the Covid-19 pandemic and Russia’s invasion of Ukraine.
In August, the UK reached a staggering high of 10.1% inflation, a number they haven’t reached in 40 years, while the Bank of England predicts that it will increase to 13% later on in the year.
It was the same for France, who reached 6.1%; a 37-year high. In the same month, the EU reached 9.1% inflation. It’s been a year of much stress for the average consumer, which begs the question: With inflation on the rise all round, will people expand their debt limits? Will credit pose a risk to markets? Do inflation expectations mean anything for consumers? We’re looking at the relationship between rising inflation and increasing credit debt, and if shoppers are turning to credit to offset the sting of rising living costs.
How rising inflation results in higher credit card debt
It is well known that each time inflation increases, governments turn to interest rates to offset the effect on economic growth and unemployment. It’s almost as if rising inflation and increases in interest rates go hand in hand as a solution for fiscal departments the world over, and it is no different today.
To sum up the chain reaction into one sentence, supply chain issues coupled with rising inflation causes higher prices in gas, food, utilities and clothing to pressure consumers into using their credit cards to make ends meet, resulting in more consumer debt and a higher dependency on borrowed money.
Let’s break this down a little further:
- Supply chain issues. Once the pandemic began to slow down, the surge in demand for anything from Korean skincare, Italian bicycles and Swiss watches outweighed the global supply chain’s ability to meet the demand.
- Something as obscure as a lack of shipping containers caused massive delays on a global scale, which resulted in businesses having to find other (more expensive) ways of shipping their products. And even if they didn’t find another way, the cost of a shipping container in 2022 rose nine times the price it was in 2019 from $1100 to $9200.
- Following this, Russia’s invasion of Ukraine sparked massive increases in inflation around the world. Russia is the world’s number one gas exporter, and with the instability surrounding the Russia-Ukraine conflict, markets became unsteady, sending inflation sky-rocketing. As gas prices rose, so did food, home essentials, utilities and more. Salary increases cannot match this speed, so consumers turn to credit cards to assist with the monthly bills.
- In the US alone, credit card balances rose by $52 billion in the last quarter of 2021 alone, showing just how dependent consumers can become on credit. This is the largest quarterly increase in 22 years. UK credit card debt is set to increase by 8%, reaching a 5-year high, and it is expected to climb another 5.5% in 2023.
European banks are tightening up
In July, the European Central Bank conducted a survey asking banks across Europe if they had seen a loosening or tightening of credit standards, which include their internal guidelines and approval criteria. Speaking specifically about the second quarter of 2022, 153 banks responded saying that they had considerably tightened credit standards on loans to businesses and home loans due to a decrease in risk tolerance in a time of low confidence in the markets and a shaky economic outlook.
However, the demand for loans increased in the second quarter and is expected to do so in the third quarter too, thanks to the increased prices of production, continued supply chain disruptions and high energy prices. Consumer credit was also tightened during the same period, with higher risk perceptions as the main reason.
At the same time, the European Parliament’s Internal Market and Consumer Protection Committee has approved new rules on credit lending, credit debt, overdrafts and loans that are unsuitable for consumers’ budgets. The new rules are part of the Consumer Credit Directive (CCD) that was created 14 years ago. Quite notably, the current state of the EU economy is the first to instigate Parliament to make changes in the 14 years the CCD has been around.
Creditworthiness, pricing rules and information regarding requirements have all been amended, with more restrictions to combat overwhelming debt. For example, consumers applying for a credit card or a credit increase will have to give more information regarding their financial obligations and living expenses. Banks can now use and ask for information from non-financial entities like a consumer’s smartphone contract provider or utilities companies to obtain information on their accounts. Although these changes are mostly positive for the long-run financial health of consumers, it may be stressful in the short term while they are reaching for borrowed money to get them through the month.
Do inflation predictions mean anything to consumers and businesses?
An essay written by Veronique de Rugy and Jack Salmon at George Mason University in the US touched on consumer expectations regarding inflation. They surmised that inflation expectations matter. Why? Because if it is known that price increases are coming tomorrow, it affects what is being spent today. If businesses can see increasing overhead and wage prices for next year, they’ll increase the price of their products this year. This is how an economy stays in the black. This sentiment is shared by the European Central Bank who published a report trying to understand consumers’ expectations of inflation, how sociodemographic factors influence those expectations, and how the role of uncertainty affects a higher or lower prediction.
The report, entitled “Making sense of consumers’ inflation perceptions and expectations - the role of uncertainty”, published in the ECB Economic Bulletin of 2021, found that higher expectations of inflation and a negative economic outlook mostly came from young females that belong to lower income and educational groups. People with a more positive outlook on the economy and a lower expectation of inflation reported having more financial comfortability. Overall, the report concluded that inflation predictions and expectations from consumers are in fact important for “the monetary transmission mechanism” - In other words echoing what de Rugy and Salmon stated above, that predictions influence today’s consumer behaviour.
Inflation: A necessary evil?
With the EU’s tightening of credit approval processes to combat overwhelming debt, and with the understanding that inflation expectations play an important role in the present and future economies of countries around the world, we can remain hopeful that the rise in inflation is not all that bad. However, inflation is not predicted to decrease for the rest of 2022 or even into 2023, bringing rise to the fears that consumers will rely on credit more often.
Understanding and dealing with inflation - as a consumer or a business - is like walking a tightrope on the edge of a mountain. As a brand or a retailer looking for space in a shopper’s cart, you’ll have to compete just that much more to get their attention and their hard-earned money. For example, a shopper will have to choose between their favourite brand of cat food versus the cheaper, maybe less nutritious brand. Or, if a consumer receives a bonus, are they going to spend it on having the latest iPhone (even though they already own one) or buying a much-needed washing machine for the very first time? This is where consumer behaviour and price elasticity meet.
Learning how brands and retailers can better navigate through times of high inflation using Dynamic Pricing is something our CEO Sander Roose is passionate about.
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