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Cost of living crisis

How high is inflation? What prices are increasing fastest? Why have prices increased so rapidly?

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What is the cost of living crisis?

The ‘cost of living crisis’ refers to the fall in ‘real’ disposable incomes (that is, adjusted for inflation and after taxes and benefits) that the UK has experienced since late 2021.

The government has responded to the crisis with several packages of support throughout this and last year, in 2022/23 household income support totalled £59.8bn and it is forecast to spend a further £21.5bn for 2023/24. 29 Office for Budget Responsibility, Economic and fiscal outlook, March 2023 The latest updates on support were announced in the Spring Budget, including an extension of the Energy Price Guarantee (EPG),  however, the recent fall in the energy price cap means this support will now end. Despite extensive government support, household incomes are not keeping up with living costs and are not expected to return to 2021 levels in real terms until 2027.

How high is inflation?

Inflation is calculated as the average change in the price of typical goods and services purchased by UK households over 12 months. This is tracked using the Consumer Price Index (CPI), calculated by the Office for National Statistics using a sample of 180,000 prices of 700 common consumer goods and services. 30 Office for National Statistics, What's in the basket of goods? 70 years of shopping history, 21 July 2016, www.ons.gov.uk/economy/inflationandpriceindices/articles/whatsinthebasketofgoods70yearsofshoppinghistory/2016-07-21 The latest data has the current CPI at 7.9% in the 12 months to June 2023. The Bank of England aims to keep the CPI rate of inflation at 2% plus or minus 1% (i.e. between 1% and 3%) and adjusts interest rates to achieve this.

How is inflation expected to change in the coming months?

Since inflation peaked at 11.1% in October 2022 the rate has been gradually coming down, although it spiked up a little in February. The latest forecasts from the Bank of England and the Office for Budget Responsibility both expect inflation to fall sharply this year, but the latest forecast from the Bank implies it will not return to the 2% target until 2024. Additionally both forecasts project an over-correction that leaves inflation below 1% until 2026.

A line chart to show CPI inflation Q1 2008 to Q1 2028, including successive Bank of England and Office for Budget Responsibility forecasts. The latest forecasts from the Bank of England and the Office for Budget Responsibility both expect inflation to fall sharply this year, but the latest forecast from the Bank implies it will not return to the 2% target until 2024.

Which prices are increasing fastest?

A rapid increase in energy costs, caused by a rise in the wholesale price of gas, has been a key driver in the increases in the price level since February 2022. Housing and household services (which include electricity and gas) as well as food and non-alcoholic beverages, made the largest annual contribution to CPIH inflation in June. 35 Office for National Statistics, Consumer price inflation, UK: June 2023, retrieved 8 August 2023, https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2023

Had the government not intervened with the Energy Price Guarantee, capping the unit cost of electricity and gas, an average household’s energy bill would have increased to over £4,000. Energy prices have been more expensive than in previous years. For example, based on typical consumption levels, the average annual gas bill in 2022 was £1,100, nearly double 2021 costs of £600. 36 Bolton P and Stewart I, ‘Domestic energy prices’, House of Commons Library, 13 March 2023, retrieved 28 March 2023, https://commonslibrary.parliament.uk/research-briefings/cbp-9491/

Energy have begun to fall with wholesale prices being their lowest since Spring last year. This is reflected in Ofgem’s latest price cap which has been set to an annual level of £2,074 for an average household. 37 https://www.ofgem.gov.uk/information-consumers/energy-advice-households/check-if-energy-price-cap-affects-you This is now below the EPG’s £2,500 cap which will end 1 July.

Price increases have become increasingly broad based over the course of this and last year. On the lower end items such as bicycles and plumbing services increased by 1% between June 2022 and 2023 while items such as frozen vegetables, olive oil, sugar and transport by air have increased by over 31%. 38 Office for National Statistics, Consumer price inflation tables, 19 July 2023, retrieved 8 August 2023, www.ons.gov.uk/economy/inflationandpriceindices/datasets/consumerpriceinflation

A chart to show the average change in consumer prices in June 2023. Items such as bicycles and plumbing services increased by 1% between June 2022 and 2023 while items such as frozen vegetables, olive oil, sugar and transport by air have increased by over 31%

Why are prices increasing rapidly?

Cost pressures have been apparent since mid-2021, driven by a range of issues from depleted gas supplies in Europe to semiconductor shortages in Asia. Impacts from the pandemic alongside disruptions to global supply chains also increased prices. 

The main contribution to higher prices has been the Russian invasion of Ukraine. Many international companies have permanently ceased operations in Russia either to comply with economic sanctions or due to reputational risk. The war has led to a shortage of Ukrainian exports such as essential car parts which has pushed up prices of second hand cars. 46 Campbell P, ‘Carmakers shut factories and freeze sales as invasion fallout spreads’, Financial Times, 2 March 2022, www.ft.com/content/f163d21f-6136-4771-ae92-d45929df820f  Agricultural commodities, such as grain and sunflower oil, are the majority of Ukrainian exports, the disruption of which has contributed to increases in global food prices.  

The biggest impact has been on gas prices, as Russia has dramatically reduced gas sales to Europe. Although the UK imports only around 13% of its total fuel (oil, gas, LNG, electricity) from Russia, it is still vulnerable to any disruption to the supply of energy to the EU, which is more reliant on Russia for its energy. Due to the integration of energy markets, UK and EU gas and electricity prices move together. The recent announcement by the European Commission to phase out EU imports of Russian oil will likely push up prices in other markets the UK uses, such as Norway and Qatar. 47 Varvitsioti E, Fleming S, and Bounds A, ‘Hungary holds up EU plan to ban imports of Russian oil’, Financial Times, 4 May 2022, www.ft.com/content/b859a4b0-65ed-49ff-ba6d-6bd9569d04ff  Gas is an important source of energy in the UK: nearly 80% of households in England are heated by mains gas and a third of electricity is generated in gas power stations. 48 Office for National Statistics, Energy efficiency of Housing, England and Wales, country and region dataset, 25 October 2022, www.ons.gov.uk/peoplepopulationandcommunity/housing/datasets/energyefficiencyofhousingenglandandwalescountryandregion   

Are incomes increasing as quickly as prices?

On the whole, no. Inflation is outstripping increases in nominal wages so incomes will fall in real terms. Wage growth since summer 2021 year has not sufficiently kept pace with inflation, between March and May 2023 the average growth in total pay was 6.9%. 49 Office for National Statistics, Average weekly earnings in Great Britain: July 2023, retrieved 08 August 2023, www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/july2023

The OBR expects nominal earnings to increase by 5% over 2023 but again inflation is expected to erode these earnings despite its anticipated downward turn. Real household disposable income (RHDI), which measures total household earnings (such as wages and benefits) after tax and accounting for inflation, fell by 2.5% in the 2022 calendar year and is expected to fall by another 2.6% in 2023. 50 Office for Budget Responsibility, Economic and fiscal outlook, March 2023.

Households receiving a part of their income from the government, through working age benefits or the state pension, see their incomes uprated each year. These were uprated by 10.1% in April 2023 as this was the CPI inflation rate last September, which is the usual reference month used to determine annual uprating. In April 2022, they increased by only 3.1% as that was the inflation rate the previous September.  

Alongside the EPG and previous government measures, the one-off Cost of Living Payments 2023/24 are offering more targeted measures to support the most vulnerable. This approach risks leaving some gaps and cliff-edges in support: the means-tested £900 government support is fully available to those entitled to it but anyone just above the threshold receives nothing. 

Which households are worst affected by the cost of living crisis?

Some households face a higher effective inflation rate because they spend a higher share of their income on energy and food, the prices of which are increasing fastest. On average, poorer households spend more of their income on these essentials. Based on November ONS price data, the Resolution Foundation estimates that the inflation rate for the poorest 10% of households is 12.5%, in contrast, it's 9.6% for the richest 10%. 51 Resolution Foundation, Cost-of-living gap between rich and poor hits fresh high, as effective inflation rate for low-income households hits 12.5 per cent, 16 November 2022, www.resolutionfoundation.org/press-releases/cost-of-living-gap-between-rich-and-poor-hits-fresh-high-as-effective-inflation-rate-for-low-income-house…; Furthermore, richer households who see big increases in the cost of the goods and services they buy may be able to adapt more easily, for example by reducing how much they save each month or changing spending on non-essentials. 

The government is providing additional support to those on lower incomes through direct payments but the expected decline in real household incomes means poor households will continue to face hardships. For example, the Joseph Roundtree Foundation has reported that 75% of the bottom 20% of low-income households in the UK (4.3 million) have gone without essentials. 52 Earwalker E, ‘Going under and without: JRF’s cost of living tracker, winter 2022/23’, Joseph Rowntree Foundation, 14 December 2022, retrieved 29 March 2023, www.jrf.org.uk/report/going-under-and-without-jrfs-cost-living-tracker-winter-202223    

Overall, the worst-affected households are those on low incomes with higher-than-average energy bills (for example if they have a large family). While these households have received additional payments from government, these are not sufficient to match the increase in energy and other costs. The energy price guarantee provides a big benefit to this group, but on average they are still worse affected by the crisis. 

How long is the cost of living crisis expected to last? 

By 2024, living costs should be increasing by less than household incomes as inflation rates fall. But prices will remain high: inflation measures the change in prices over a 12-month period, and falling inflation only means prices are rising less quickly, not that they are falling. 

Based on the latest forecasts, it will take a long time for household incomes to recover to their previous level in real terms. RHDI per person, a measure of living standards will not return to its 2021/22 level until 2027/28. And in that year living standards will still be below pre-pandemic levels in real terms, meaning that the effects of the cost of living crisis are likely to be felt for a long time.   

Political party
Conservative
Department
HM Treasury
Publisher
Institute for Government

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