How cost of living pressures will impact UK consumer spending

Energy prices will be higher for longer — hitting lower-income households the hardest

The weaker growth outlook mainly reflects the likelihood that energy prices will stay higher for longer than previously expected, adding to cost of living pressures and weighing on consumer spending. We now expect inflation to peak at 8.5% in April and still be around 6% by year-end. The rising price of capital goods, and any further disruptions to global supply chains will also limit the extent of any rebound in business investment.

Against this background, we’ve revised down our projection for consumer spending growth from 5.6% to 5.1% in 2022 and from 2.9% to 1.7% next year, mainly reflecting the negative impact of higher inflation on real incomes. High and low-income households have faced similar inflation rates recently, with low-income households particularly impacted by higher energy costs, whilst those who are better-off financially have borne the brunt of rising petrol prices. But April’s 54% rise in the typical energy bill will disproportionately hit poorer households, with inflation facing that group set to reach close to 10%. With another jump in energy bills likely in October, people lower down the income scale could face the impacts of persistently higher inflation until well into 2023.

Real wages will slump, but consumer spending will still benefit from some tailwinds

Higher inflation isn’t necessarily a major problem for consumer spending if it’s compensated for by rising wages. The post-war decade with the highest average inflation – the 1970s – was also the decade where households enjoyed the strongest growth in real incomes. But the decline in workers’ bargaining power since then suggests pay won’t keep pace with prices. This means that 2022 is likely to see the biggest fall in real wages since the global financial crisis. 

However, consumer spending does have some supporting factors. UK unemployment is close to record lows, and there’s scope for the number of people in work to recover further as the impacts of the pandemic fade. The dampening effect of cost of living pressures may be partly offset by households running down savings and spending new wealth built up during the pandemic. Also, many consumers have created more space to borrow by paying down unsecured debt. And the declining proportion of households with a mortgage, plus the dominance of fixed-rate mortgages, will limit rising interest rates’ impact on spending. 

However, most of these factors protect high-income households much more than low-income households. It was households in the top half of the income distribution who saw their savings increase most during the pandemic, while many low-income households were compelled to spend more and save less. And ownership of housing and financial assets is largely the preserve of higher-income groups, whose lower propensity to spend savings reduces the likelihood of a savings-fuelled splurge.