Inflation has dropped significantly over the last six months. The consumer prices index, the most watched of the inflation measures, has trimmed close to a third off its 5.2% high in September 2011, ending at 3.5% in March this year.
And the retail prices index, which includes the costs of housing, also saw a substantial reduction from its 5.6% high in September 2011 to 3.6% in March 2012.
That is obviously a positive development which attenuates, but doesn’t eliminate, the vicious squeeze households have experienced over the past two years – a period during which inflation has significantly outpaced wage growth.
To put it in perspective, the same basket of goods and services that in January 2010 would have cost £100 would go for £110.50 today – at least based on government statistics.
And the £100 weekly total pay the average wage earner would have collected in January 2010 would have increased to only £105.2 by March 2012. Conclusion – we are getting poorer.
Averages, however, are deceptive. Pay raises, for one, have an uneven distribution, with the segment of the population that works in finance and business services seeing on average each £100 of their January 2010 total pay climb to £111.20 by March 2012, comfortably keeping up with inflation.
But the picture for those working in construction is a lot bleaker, with average total pay today flat compared with where it was 27 months ago.
Other segments of the economy fall between these two extremes. And inflation also impacts on people differently.
“With wage growth stuck in first gear and the outlook for inflation clouding over, more erosion of our purchasing power is guaranteed”
As for goods and services prices, research by the Institute for Fiscal Studies for Consumer Focus, the statutory consumer champion for the UK, found that from 2000 to 2010 inflation averaged 3.5% for the second to lowest income decile – a decile being one of 10 equally-sized groups of the population – while the highest income decile experienced a much lower average inflation rate of 2.9%.
The reason for this is straightforward. The lower the income, the more food, clothing, fares and travel, and fuel and light costs represent in terms of household expenditure. And these are the areas of highest inflation, up for the 12 months ending in March of this year by 4.7% for food, 10.4% for clothing, 4.9% for fares and travel costs, and 11.3% for fuel and light.
So what does all this mean? Effectively, the average person on the street has suffered a sizeable pay cut over the last 27 months as wages grew at a substantially lower rate than inflation. And to make matters worse, the lower one is situated on the income ladder, the harsher the bite has been.
With inflation on a downward trend, shouldn’t things be looking better, then? Well, maybe or maybe not. The March 2012 CPI reading of 3.5% is an uptick from February’s 3.4%, the first rise in six months.
This has clearly raised some concern among members of the Monetary Policy Committee, with Paul Tucker, deputy governor of the Bank of England, commenting that inflation is uncomfortably high and will probably not fall as fast as the Bank has forecast, and fellow MPC member Adam Posen abandoning his dove-ish position as a strong supporter of additional quantitative easing.
That is quite a turnaround for the Bank, which through the past 28 months – during which inflation significantly exceeded its 2% objective – had been consistent in its views that this was transitory and would soon be back on target.
In its forecast for 2012 the Council of Mortgage Lenders projected increases of 8% to 180,000 cases and 22% to 45,000 cases for arrears and possessions respectively.
“The household sector has been under financial pressure for some time as a result of falling real incomes, and more recently higher unemployment,” it states. “This is likely to unwind some of the improvement in mortgage arrears we have seen over the past two years and lead to a somewhat higher level of possessions in 2012.”
At the time, the Bank was predicting the end of high inflation. Given what we know today, the CML’s predictions for 2012 appear to have been prescient and one has to hope that they will not end up being too conservative.
Certainly, among a number of portfolios managed by us, we noted significant signs of duress related to inflation pressures as early as the beginning of 2011.
A weak economy and stubborn inflation are not a good mix. The anaemic recovery, unsettled eurozone and high unemployment all contribute to limiting wage earners’ bargaining power. With wage growth stuck in first gear and the outlook for inflation clouding over, more erosion of our purchasing power is guaranteed.
This will be particularly tough on the lower income section of the population, as well as on those who are already having problems making ends meet.