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Posted on 01/06/2017

How inflation and a wage squeeze are impacting consumers

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The Bank of England has said it expects living standards to fall this year as we begin to feel the financial effects of last year’s Brexit vote.

Mark Carney, Governor of the Bank, warned that households would be facing a “more challenging time” as inflation rises during 2017. Inflation, already at a three-year high, is likely to stall wage growth, leaving consumers struggling with their finances.

Effects of Brexit

The report comes amidst parties’ campaigning for the general election on June 8, with Brexit negotiations lying further along the horizon. Carney started his press briefing by commenting on the effect that political uncertainty is having on the economy:

“The outlook for UK growth and inflation will continue to be influenced by the response of households, companies and financial markets to the prospects for the UK’s departure from the EU.”
Sterling’s decline since the vote to leave the European Union has raised the costs of importing and is considered to be one of the main causes of the increase in inflation. But the Bank says a recent rise of the pound could be “reflecting market expectations of a more orderly Brexit process”.

Strain on households

The Bank’s prediction for average earnings growth for the year was markedly cut to two per cent from the three per cent forecast in February. The Resolution Foundation think tank calculated that, relative to inflation, average pay would drop by 0.8% for the year, leaving workers with £915 less than predicted back in May last year.

Carney explained companies’ reluctance to increase wages:

“Uncertainty of companies about the outlook may also have made them unwilling to raise wages at a faster pace until they have more clarity about future costs and market access.”
Consumer spending has been crucial for a growing economy since the financial crisis. So, with households under more strain, it is unsurprising that the Bank predicts GDP growth to slow to 1.7 per cent over the next two years.

There were, however, brief glimpses of better news in the report.

Mixed economic outlook

Earlier in the year, the UK lost its place as the fastest growing economy in the G7. But the weak pound and continuing demand for exports has seen trade performance improve and a boost in foreign business investment. The Bank expects this to help offset the decline in consumer spending.

Indeed, after a sobering report for this year, Carney predicts wage growth to start to climb after 2017 and for unemployment to remain low. 

Interest rates were again held at record lows of 0.25% but it seems likely the Bank will have to raise them back to 0.5% sooner than expected. And many companies are factoring further rises into their projections.

However, Suren Thiru, Head of Economics at the British Chambers of Commerce, is concerned the Bank’s forecast is not realistic:

“We expect that inflation will weaken economic activity by more than the central bank is currently predicting, with wage growth likely to remain persistently below price growth over the next few years. Rising input costs faced by businesses are also likely to weigh more heavily on investment intentions than the Bank of England forecasts currently imply.”

With contrasting views from economists, we will have to wait and see how political and economic issues interact. But for the time being, it seems households may need to monitor their finances more closely.