Why are prices increasing rapidly?
Cost pressures have been apparent since mid-2021, driven by a range of issues from depleted gas supplies in Europe to semiconductor shortages in Asia. Impacts from the pandemic alongside disruptions to global supply chains also increased prices.
The main contribution to higher prices has been the Russian invasion of Ukraine. Many international companies have permanently ceased operations in Russia either to comply with economic sanctions or due to reputational risk. The war has led to a shortage of Ukrainian exports such as essential car parts which has pushed up prices of second hand cars. 46 Campbell P,‘Carmakers shut factories and freeze sales as invasion fallout spreads’, Financial Times, 2 March 2022,www.ft.com/content/f163d21f-6136-4771-ae92-d45929df820f Agricultural commodities, such as grain and sunflower oil, are the majority of Ukrainian exports, the disruption of which has contributed to increases in global food prices.
The biggest impact has been on gas prices, as Russia has dramatically reduced gas sales to Europe. Although the UK imports only around 13% of its total fuel (oil, gas, LNG, electricity) from Russia, it is still vulnerable to any disruption to the supply of energy to the EU, which is more reliant on Russia for its energy. Due to the integration of energy markets, UK and EU gas and electricity prices move together. The recent announcement by the European Commission to phase out EU imports of Russian oil will likely push up prices in other markets the UK uses, such as Norway and Qatar. 47 VarvitsiotiE, Fleming S,and Bounds A, ‘Hungary holds up EU plan to ban imports of Russian oil’, Financial Times, 4 May 2022,www.ft.com/content/b859a4b0-65ed-49ff-ba6d-6bd9569d04ff Gas is an important source of energy in the UK: nearly 80% of households in England are heated by mains gas and a third of electricity is generated in gas power stations. 48 Office for National Statistics, Energy efficiency of Housing, England and Wales, country and region dataset,25 October 2022,www.ons.gov.uk/peoplepopulationandcommunity/housing/datasets/energyefficiencyofhousingenglandandwalescountryandregion
Are incomes increasing as quickly as prices?
On the whole, no. Inflation is outstripping increases in nominal wages so incomes will fall in real terms. Wage growth since summer 2021 year has not sufficiently kept pace with inflation, between March and May 2023 the average growth in total pay was 6.9%. 49 Office for National Statistics, Average weekly earnings in Great Britain: July 2023, retrieved 08 August 2023, www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/july2023
The OBR expects nominal earnings to increase by 5% over 2023 but again inflation is expected to erode these earnings despite its anticipated downward turn. Real household disposable income (RHDI), which measures total household earnings (such as wages and benefits) after tax and accounting for inflation, fell by 2.5% in the 2022 calendar year and is expected to fall by another 2.6% in 2023. 50 Office for Budget Responsibility,Economic and fiscal outlook, March 2023.
Households receiving a part of their income from the government, through working age benefits or the state pension, see their incomes uprated each year. These were uprated by 10.1% in April 2023 as this was the CPI inflation rate last September, which is the usual reference month used to determine annual uprating. In April 2022, they increased by only 3.1% as that was the inflation rate the previous September.
Alongside the EPG and previous government measures, the one-off Cost of Living Payments 2023/24 are offering more targeted measures to support the most vulnerable. This approach risks leaving some gaps and cliff-edges in support: the means-tested £900 government support is fully available to those entitled to it but anyone just above the threshold receives nothing.
Which households are worst affected by the cost of living crisis?
Some households face a higher effective inflation rate because they spend a higher share of their income on energy and food, the prices of which are increasing fastest. On average, poorer households spend more of their income on these essentials. Based on November ONS price data, the Resolution Foundation estimates that the inflation rate for the poorest 10% of households is 12.5%, in contrast, it's 9.6% for the richest 10%. 51 Resolution Foundation,Cost-of-living gap between rich and poor hits fresh high, as effective inflation rate for low-income households hits 12.5 per cent, 16 November 2022,www.resolutionfoundation.org/press-releases/cost-of-living-gap-between-rich-and-poor-hits-fresh-high-as-effective-inflation-rate-for-low-income-house… Furthermore, richer households who see big increases in the cost of the goods and services they buy may be able to adapt more easily, for example by reducing how much they save each month or changing spending on non-essentials.
The government is providing additional support to those on lower incomes through direct payments but the expected decline in real household incomes means poor households will continue to face hardships. For example, the Joseph Roundtree Foundation has reported that 75% of the bottom 20% of low-income households in the UK (4.3 million) have gone without essentials. 52 EarwalkerE, ‘Going under and without: JRF’s cost of living tracker, winter 2022/23’, Joseph Rowntree Foundation, 14 December 2022,retrieved 29 March 2023, www.jrf.org.uk/report/going-under-and-without-jrfs-cost-living-tracker-winter-202223
Overall, the worst-affected households are those on low incomes with higher-than-average energy bills (for example if they have a large family). While these households have received additional payments from government, these are not sufficient to match the increase in energy and other costs. The energy price guarantee provides a big benefit to this group, but on average they are still worse affected by the crisis.
How long is the cost of living crisis expected to last?
By 2024, living costs should be increasing by less than household incomes as inflation rates fall. But prices will remain high: inflation measures the change in prices over a 12-month period, and falling inflation only means prices are rising less quickly, not that they are falling.
Based on the latest forecasts, it will take a long time for household incomes to recover to their previous level in real terms. RHDI per person, a measure of living standards will not return to its 2021/22 level until 2027/28. And in that year living standards will still be below pre-pandemic levels in real terms, meaning that the effects of the cost of living crisis are likely to be felt for a long time.
I'm an economic expert with a deep understanding of the factors influencing price movements and their cascading effects on various aspects of the economy. My expertise is grounded in a comprehensive knowledge of global economic dynamics, supply chain management, and geopolitical events.
The article you provided outlines the reasons behind the rapid increase in prices and the subsequent challenges faced by households, particularly in the UK. Let's break down the key concepts mentioned:
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Cost Pressures Since Mid-2021:
- Depleted gas supplies in Europe.
- Semiconductor shortages in Asia.
- Pandemic-related disruptions to global supply chains.
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Russian Invasion of Ukraine (Main Contributor to Higher Prices):
- Many international companies ceasing operations in Russia due to economic sanctions or reputational risks.
- Shortage of Ukrainian exports, such as essential car parts, leading to increased prices of second-hand cars.
- Disruption of Ukrainian agricultural commodities (grain and sunflower oil), contributing to global food price increases.
- Russia's significant reduction in gas sales to Europe impacting gas prices.
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Impact on Gas Prices:
- The UK, although importing only around 13% of its total fuel from Russia, is vulnerable to energy supply disruptions due to integration with the EU energy market.
- The European Commission's decision to phase out EU imports of Russian oil may affect prices in other markets the UK relies on, such as Norway and Qatar.
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Incomes vs. Prices:
- Inflation is outpacing increases in nominal wages, leading to a decline in real incomes.
- Wage growth has not kept pace with inflation, with the average growth in total pay at 6.9% between March and May 2023.
- The Office for Budget Responsibility expects nominal earnings to increase by 5% in 2023, but inflation is anticipated to erode these earnings.
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Household Income and Support:
- Real household disposable income (RHDI) fell by 2.5% in 2022 and is expected to fall by another 2.6% in 2023.
- Households receiving government income see upratings, with a one-off Cost of Living Payments in 2023/24 offering targeted support.
- However, there are concerns about gaps and cliff-edges in support, where some may receive nothing just above the entitlement threshold.
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Impact on Different Households:
- Poorer households face a higher effective inflation rate as they spend a larger share of their income on essentials like energy and food.
- The Resolution Foundation estimates an inflation rate of 12.5% for the poorest 10% of households, compared to 9.6% for the richest 10%.
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Duration of the Cost of Living Crisis:
- Living costs are expected to increase less than household incomes by 2024 as inflation rates fall.
- However, prices will remain high, and it will take until 2027/28 for real household disposable income per person to return to its 2021/22 level.
In conclusion, the multifaceted factors contributing to the cost of living crisis, coupled with the complex interplay between global events and domestic economic conditions, underscore the challenges faced by households in the current economic landscape.
