The cost-of-living squeeze – low inflation to the rescue?

11 September 2023

Please join me for our annual ‘Back to School’ webinar this Wednesday, 13 September, at 13:00 BST, as I examine prospects for the UK and global economies.

Inflation is finally falling and it’s easing the pressure on consumers. From a peak of 11.1%, UK inflation dropped to 6.8% in July and is likely to fall below 3.0% by next summer. After an 18-month decline, real wages are rising. Growth in nominal pay has accelerated since late 2021 with the latest numbers showing that total pay, including bonuses, increased by 8.2% in the three months to June on a year earlier. Buoyant earnings and falling inflation mean that real wage growth is likely to outstrip inflation for the rest of this year and next.

On the face of it the hard squeeze on consumer spending power is over. The reality is more complex.

Disposable income is not only a function of wages and inflation. Benefits, taxes, employment and housing costs play a role too. For many households, especially those on lower and middle incomes, these factors will increasingly weigh on spending power. An excellent report released last week by the Resolution Foundation analysed these pressures (“The Living Standards Outlook”, Summer 2023 Update).

The most obvious headwind is rising mortgage payments, paid by about one-third of UK households. With the majority of homeowners on fixed-rate mortgages, the effect of higher base rates feeds through only gradually to monthly mortgage payments. The Resolution Foundation estimates that roughly half of the likely increase in rates has fed through to homeowners. Most of the further increases will come through by the end of next year. Those remortgaging between now and the end of next year will, on average, see their annual payment rise by about £3,000.

A further third of UK households rent and their costs are rising too. Social rents, paid by council and housing association tenants, are linked to inflation, and could rise by up to 7.9% next April. In the private sector new rental costs have far outstripped inflation, rising by 33% since the pandemic, according to estate agents Rightmove. Because rents tend to reset when new tenants move in, average rental costs have risen more slowly. But over time, as the stock of accommodation turns over, a growing proportion of tenants will find themselves facing higher rents.

Spending power is also affected by taxes and benefits. The government plans to freeze tax thresholds until 2028, bringing an increased share of income into tax. The Resolution Foundation estimates that for the median employee, real, post-tax pay will increase at roughly one-third the rate of pre-tax pay between 2019-20 and 2027-28. On the benefit side extra payments to lower-income households during the pandemic and the energy crisis are coming to an end. The ending of these payments will lead to a reduction in real incomes for many benefit recipients next year. (The special schemes are a weekly £20 uplift to benefits and extra support for council tax, energy bills and to deal with higher inflation.)

The final factor to consider is employment. The labour market has cooled in recent months and the unemployment rate has risen from 3.5% to 4.2%. GDP growth is likely to remain weak until around the middle of next year and the unemployment rate is likely to continue to rise, though to levels far below previous cyclical peaks. Higher unemployment will act as a further headwind for the consumer.

One significant offsetting source of support for consumer spending comes in the form of rising interest income. The Resolution Foundation estimates that next year households’ income from savings will rise by £30bn.

The effect of all of these changes varies across the income distribution and household type. Older households, those that own their homes outright (who account for about one-third of all households) and those higher up the income scale will tend to fare better than renters and mortgage holders and those in the lower half of the income distribution, particularly households on benefits.

For the median non-pensioner household, the Resolution Foundation estimates that real incomes after housing costs will stagnate in 2024-25. The typical real incomes for those with mortgages or renting will fall, while outright owners will see their disposable income rise partly because of rising income from savings. The 10% of UK households with the most savings will receive about two-thirds of interest income in 2024-25.

So among the non-pensioner population median real incomes seem likely to stagnate in 2024-25 and for those on less than median incomes spending power will fall. Those in the upper half of the income distribution, many of them savers or outright property owners, will see their real incomes rise.

The distribution of income is what matters for individual households, but what matters for overall consumer spending is total spending power. That is likely to rise driven by gains for those on above-median earnings. Since the top 50% of UK households account for almost 70% of all spending it’s perfectly possible for consumer spending to rise when median incomes are flat or falling. This is what seems likely to happen next year.

The worst of the squeeze on incomes is probably behind us. Falling inflation and rising savings income will boost overall spending power from here. But for households coping with rising rents, mortgage payments and taxes, it may not feel like much of a turning point.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.htm

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.2% at 7,478.

Economics

The UN warned that the world is not on target to meet previously agreed climate commitments and called for more action on all fronts
The price of oil rose above $90/barrel last week for the first time in almost ten months following production cuts by Russia and Saudi Arabia. The development may reverse some of the falls in inflation seen in advanced economies
European natural gas prices rose following strike action by workers at a liquified natural gas plant in Australia that accounts for 7% of global supply
The UK government will be closely watching when average earnings figures for the UK are published tomorrow – the increase in earnings, expected to be over 8%, is likely to determine the rise in the state pension next year as part of the ‘triple lock’
UK house prices fell by 4.6% in the year to August with a 1.9% decline just in the last month, according to estimates from Halifax
A number of UK mortgage lenders are cutting mortgage rates amid the slowing housing market
The Bank of England governor Andrew Bailey said: “I'm not therefore saying we're at the top of the cycle, because we've got a meeting to come, but I think we are much nearer to it, on interest rates, on the basis of current evidence”
UK businesses are planning to raise prices by 4.9% over the next year, according to a Bank of England survey, the lowest such reading since the invasion of Ukraine
UK public health officials said that COVID variant BA.2.86 was spreading in England but that it was too early to conclude if it was more serious than previous variants
German industrial production fell by a greater-than-expected 0.8% from June to July while industrial orders fell by 11.7% and exports fell by 0.9% over the same period, highlighting the slowing momentum in Europe’s largest economy
US jobless claims unexpectedly fell, the most recent in a number of data releases that point to continued resilience in the US labour market
US headline inflation for the 12 months to August is expected to pick up to 3.6% when figures are published on Wednesday
Three policymakers at the US Federal Reserve appeared to hint at their support for a pause to further rate rises

Business

The UK government’s annual auction for wind power projects failed to attract any bidders amid rising costs for labour, turbines and financing
The share price of technology giant Apple fell after reports that the Chinese government has banned some public officials from using foreign-made phones including iPhones
The UK competition authority upheld a ruling by the UK aviation regulator that forced Heathrow Airport to cut its landing fees
Concerns grew in the UK that courts, hospitals, prisons and other buildings across the public and private sectors in addition to at least 147 schools could contain reinforced autoclaved aerated concrete, which is prone to collapse
One in eight UK bank branches will close this year
The average cost of renting a room in London has exceeded £1,000 a month for the first time, according to SpareRoom
Some 1,300 Wilko employees were made redundant and an additional 52 stores will close as the administration of the UK retailer continues
Royal Mail is seeking to end Saturday deliveries to cut costs
Businesses in London’s West End have criticised the government’s decision to stop tax-free shopping for tourists as having a greater effect on their business than the rising cost of living
UK retailer Halfords announced rising sales driven by its car servicing and repair businesses despite a fall in cycling revenue

Global and political developments

The US and Vietnam have tightened diplomatic links in a move designed to counter China’s growing assertiveness
The UK is to rejoin the EU’s €96bn Horizon research programme; some commentators expressed hope that further UK-EU deals may follow
Germany is asking the European Commission to delay tariffs on electric vehicle trade between the UK and EU that are due to commence in January, the FT reports
Birmingham City Council declared itself effectively bankrupt after facing a bill of £760m to settle historic pay discrimination claims
Scottish first minister Humza Yousaf said that the Scottish government “shouldn’t rule wealth taxes off the table” amid budget pressures
North Korea unveiled a submarine it claims can be armed with nuclear weapons

And finally… Lincolnshire Police were called to reports of a “ritual mass murder” after members of the public saw people lying on the floor inside a café in Chapel St Leonards last Wednesday. Thankfully once officers reached the potentially gruesome scene, they determined that it was in fact a yoga class – despite this, it is believed that the participants may be facing a long stretch

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