Business

Falling household spending power is painful part of the cure for inflation

The sharp rise in inflation is a bill that’s been in the post for the British economy since the spring.

It’s finally landed on the national doormat, but the fact we knew it was coming will not make it any easier to pay.

The chief driver of CPI reaching 11.1%, a one percentage point leap to a 41-year high, is the rising cost of energy finally reaching households.

Thanks to the price cap mechanism operated by energy regulator Ofgem, and now the government’s energy price guarantee (EPG), the real cost of domestic gas and electricity is only fed through to consumers gradually.

While other parts of the economy reflected the soaring cost of wholesale gas, particularly food production, energy bill payers were protected through the summer by the price cap, set in April, of £2,000 for “typical use” for a family in a three-bedroomed house.

That changed in October, when typical bills went up to £2,500.

Consumers still have some protection, with the EPG capping unit prices of gas and electricity, but the leap in domestic outgoings accounts for almost all of the increase in inflation.

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Without the support it would have been even worse.

Before the government announced its energy support plan, Ofgem predicted bills of closer to £3,500 and the Bank of England forecast inflation would reach 13%.

Thanks to the EPG, unit prices of gas and electricity increased last month by around 25% rather than 75%.

Even so, households are paying a staggering 90% more for gas, electricity and fuel oils than they were a year ago.

Consumers have had no such protection from the impact on food prices, up 16.4% year-on-year in October.

That reflects the impact of energy costs on the three F’s fundamental to agriculture – feed, fuel and fertiliser – and may add a fourth ‘F’ when shoppers get to the checkout.

This combination has a particularly severe impact on the poorest households, who spend a greater proportion of their income on energy and food bills.

The Office for National Statistics says that ‘real’ inflation for the poorest 30% of households is more than 12%, compared to a little over 10% for the richest third.

Even if the volatile impact of energy and food prices is stripped out, underlying “core inflation” remains at 6.5%, a figure that the Bank of England’s monetary policy committee will be wary of at its next meeting in December.

While today’s figures may signal the peak of inflation, it is highly unlikely the Bank is done with raising interest rates.

After eight consecutive upward steps, this inflation figure makes another more likely before Christmas, and perhaps again in February.

The Bank’s aim is to prevent inflation “imported” in high energy prices becoming embedded if and when they fall.

Wages have been rising as employers struggle to fill vacancies in a tight labour market, but even with average pay increases of 6%, real wages are still falling by 3.7% once CPI is factored in.

The hope is that even if energy support is reduced by the chancellor in his autumn statement on Thursday and bills rise again in April, the hike will be less than in April this year.

We may also begin to see downward pressure on prices as a consequence of the nascent recession, and hikes in interest rates here and globally, both of which should begin to reduce demand.

Higher energy bills and falling spending power are not a recipe for a great Christmas, but they are a painful part of the cure for inflation.

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