Price rises are set to outstrip pay rises well into the future, and the squeeze on incomes poses a real problem for the chancellor
Higher than expected inflation is a problem for George Osborne. He needs upward pressure on the cost of living to abate so that the squeeze on real incomes comes to an end well before the next election in May 2015. The latest official data shows that the moment when wages start growing more quickly than prices is still some way off.
At present, pay is going up by just over 1% while inflation as measured by the consumer prices index is rising at an annual rate of 2.7%. The City had expected a small fall last month to 2.6% but dearer food put paid to that. September’s CPI is used to uprate pensions, so the elderly will benefit from the failure of inflation to fall – but only by 10p a week. Don’t spend it all at once.
Apart from one relatively brief period in 2009, inflation has now been above the government’s 2% target for six years. Rising global food and energy prices have something to do with this, but even so inflation in the UK is higher than in either the US or the European Union. Prices have proved relatively sticky in the UK; inflation has come down from its recent peak of just over 5% but it has been a slow process. For most of the past year CPI inflation has been in a range from 2.7%-2.9%.
Were this trend to persist, it would put the Bank of England in difficulties. When Threadneedle Street issued its forward guidance on interest rates in September, it said borrowing costs would remain at 0.5% at least until unemployment came down to 7% but made the pledge subject to three “knockouts”. One involved the inflation rate: the Bank said it might have to move earlier if the cost of living was forecast to be above 2.5% in 18-24 months’ time.
Neither the Bank nor the City see this as an immediate danger. The hope is that inflation will come down over the coming months because increases in food and energy bills will be lower this year than they were in 2012. But there is no prospect – as seemed possible a couple of months ago – that inflation will be back to 2% by the end of the year. That means that the pressure on living standards will persist, helping to explain why the overnment has been so keen to limit rail fare increases and to freeze petrol duty.
The struggle for many households to make ends meet means that, with one proviso, it seems unlikely there will be a surge in inflation even at a time when the economy is in recovery. That proviso is that the UK avoids a housing bubble.
Should that happen and the economy again be gripped by the sort of irrational property exuberance that in the past has encouraged debt-finance consumption, the modest downward trend in inflation expected in late 2013 and early 2014 would be reversed.
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