It is four years since the UK’s cost of living crisis started making the headlines, which is quite a long time. At first, talk of such a crisis was regarded as a little quaint, so accustomed had we become to low inflation, albeit alongside stagnant real wages. Indeed, the initial impact of the pandemic was to push inflation down further, to just 0.2 per cent in August 2020 and 0.4 per cent in February 2021.
That was the lull before the storm — and, long after it was supposed to have abated, that storm continues. Inflation, as you will know, is now 3.8 per cent, almost double the official target rate of the Bank of England. It rose above that 2 per cent target in August 2021 and has only been at or below it for three of the past 48 months.
Last week brought unwelcome news that household energy bills will rise again in October. The increase in the energy price cap on a year earlier is a modest 2.2 per cent to £1,755 a year for average households, which the energy regulator Ofgem says is a fall in inflation-adjusted terms.
• Energy bills to rise to fund cost of switching off wind farms
For most households, though, a rise is a rise — however you cut it. It comes as food manufacturers and retailers say that food price inflation, which has accelerated from 1.5 per cent to 4.9 per cent over the past year, is set to go even higher between now and the end of the year.
For many people, to use an expression favoured by one of my former editors, it looks like thin gruel. It is early days, much too early, but you may already have seen pieces about how much more this year’s Christmas dinner will cost than last year’s. The continued increases in food prices and in household bills, including council tax and water, as well as energy, have become the reality.
And the thing about these rises for necessities is that they are both highly visible — people notice price increases more when they are for regular purchases — and hard to avoid. That is why their impact on the economy is so significant.
• UK food price inflation jumps to 17-month high
Official figures suggest that real wages — average earnings adjusted for inflation — have been climbing for the past two years, if only modestly, and continue to do so. In normal circumstances, rising real wages would be associated with a healthy increase in consumer spending.
But the concentration of price rises in essentials — the continued cost of living crisis — means that this has not been happening. Consumer spending rose by a very subdued 0.5 per cent in 2023, and by just 0.6 per cent last year. It looked as though it might be finding its feet in the first quarter of this year, rising by 0.5 per cent in the January-March period, before subsiding to a trickle of 0.1 per cent growth in the second quarter.
Retail sales figures from the Office for National Statistics are having a bit of a moment and publication of the July data has been slightly delayed, but the bigger picture is fairly clear. Retail sales volumes this June were 10 per cent lower than in April 2021, when the final Covid lockdown ended, and 7 per cent below where they were in August 2021, when inflation embarked on its prolonged above-target stretch.
The latest CBI distributive trades survey, published a few days ago, suggested that the malaise continues. Retail sales were said to be both down this month, compared with a year ago, and poor for the time of year. Retailers were downbeat about prospects, the survey said.
For the retail sector — and for hospitality, which is to be congratulated on the vigour and visibility of its campaign against the Rachel Reeves hike in employers’ national insurance contributions — the government has made a difficult situation worse. Households cannot spend the same pound twice — money used for food and essential bills cannot be spent on clothes, furniture, electronics, entertainment and eating out — and so higher prices in one area affect affect how much can be afforded in another. And demand is weak, as highlighted by the CBI’s survey.
• UK retail sales fall at fastest pace in more than two years, says CBI
The tax-hit hospitality sector is not profiteering — official figures show that restaurant and café prices are up by a fairly modest 4.2 per cent on a year ago — but it too is affected by demand.
Having spent a few days in a famous Welsh seaside resort, I found myself wincing at the bills being racked up by families with children, even at quite modest establishments. People cannot afford to do that too often.
I wince even more when expected to give a tip on top of the service charge, a practice imported from America (where the service charges are also typically much higher than here), which I hope does not become too widespread, though I have only so far encountered it in London.
Governments get blamed for the cost of living crisis, as do central banks, including our own Bank of England. It was one of the key factors in the Tories’ landslide defeat in last year’s general election, and in the Democrats’ defeat in America. The cost of living crisis that Donald Trump inherited has, if anything, deepened, partly because of his highly damaging tariffs.
Central banks, whose main job is to control inflation, also deserve to get it in the neck, though there was not much the Bank could have done to prevent most of the energy-driven price rises that pushed inflation to 11 per cent nearly three years ago.
That is the issue. While some of the rise in food and energy prices is due to domestic factors, any ending of the cost of living crisis also rests on an easing of international pressures. To be fair, after exerting a massive influence on energy prices in the UK three years ago, international prices of gas and oil have been flat over the past year. But food commodities were 8 per cent higher last month than a year earlier, and the effect of that can be seen clearly in some retail prices for food.
Even though some of the inflation we have experienced is outside the control of the authorities in the UK, they have to deal with the consequences. A four-year cost of living crisis has not gone unnoticed by individuals or businesses.
The Bank noted in this month’s monetary policy report that the medium-term inflation expectations of households continued to increase and were now “materially” above historical averages. Inflation expectations among businesses has also risen, and appear to be more sensitive to short-term changes in measured inflation.
People and firms are no longer as confident in the ability of the Bank to control inflation and bring it back to heel. After four years of high inflation and a cost of living crisis, that is not surprising — but it is rather worrying.
PS
Many people say that, rather than fiddle around with small tax changes to stay on track to meet her fiscal rules, the chancellor should grasp the nettle and increase income tax or VAT. It would break manifesto commitments but demonstrate a no-nonsense approach.
Income tax is, of course, already going up as a result of the long freeze on allowances and thresholds. The last increase in the basic rate of income tax was 51 years ago, by Denis Healey, though there was a more recent increase in the highest rate of tax — the additional rate — which was introduced at a 50 per cent rate at the tail-end of the 1997-2010 Labour government.
VAT was increased from 17.5 per cent to 20 per cent by George Osborne, with effect from 2011.
I was always struck by the number of people who got in touch expecting VAT, which replaced the old purchase tax when we joined the European Economic Community, to be abolished if we voted to leave the EU. No such luck — and nor was there the slightest prospect of it.
Putting up VAT would, even if less damaging to incentives than increasing income tax, add to inflation at a time when, as outlined above, it is already well above target. This is not the time.