Three years of record inflation, peaking at 11.1 percent in October 2022, has changed behaviour as people in the UK now spend less and save more, research from the Resolution Foundation has shown.
The cost of living rose sharply during 2021 and 2022, but official data scheduled for release on Wednesday 22 May is expected to show consumer price index (CPI) inflation returning to close to the 2 percent target set by the Bank of England.
The Resolution Foundation research showed that the UK’s inflation shock, with figures reaching a high not seen for more than four decades, was the biggest among the G7 economies. It was also the third highest among OECD advanced countries, only lagging Sweden and Iceland.
Essentials price hike
Since March 2021, prices overall have risen by 22 percent. This is 15 percent higher than if inflation had stayed at its two per cent target, researchers said.
However, the cost of essentials has risen by a lot more.
The research showed energy prices had increased 90 percent and food costs went up 31 percent during the three years of spiking inflation.
Poorer families were particularly hard hit as 50 percent more of their total spending goes on essential items compared to richer households, the foundation said.
Shift in saver behaviour
In spite of expectations that households would use savings or borrow to deal with rocketing prices, the foundation found that the cost of living crisis has in fact turned the UK from a population of spenders to savers. Rather than burn through their savings, households cut their consumption by even more than their incomes have fallen.
Real household disposable income per person has fallen by 1.1 percent, or £280 a year, since before the pandemic (measured as the fourth quarter of 2019), yet real consumption per person has fallen much further, by 4.7 percent, or £1,200 a year.
In the last three months of 2023, families saved 6 percent of their disposable incomes. This is the highest level of saving, excluding the pandemic years, in more than 30 years.
The research found that if they had saved at the lower levels seen in 2019, this would have boosted aggregate spending by £54 billion a year.
Consumption slashed
This surprise savings boost has seen households cut down sharply on the amount they consume. For example, energy consumption fell by as much as 11 percent from that seen in the first quarter of 2022, while food was down 7 percent. Spending on luxury items, such as fridges and crockery, was down 18 percent.
As the cost of living crisis has eased over the past year, the report’s authors said that almost all of the financial gains from falling energy prices has been spent on going out or travelling abroad. Spending on goods has not recovered, they added.
Unfortunately, the UK has also bucked another historic trend seen during inflationary shocks: it has not reduced the national debt. During previous periods of high inflation in the 1950s, which saw a peak of 11 percent, and in the 1970 to 1980s, with a peak of 23 percent, the UK was able to “inflate away its national debt”, researchers said, as the debt fell by 11 and 7 percentage points respectively.
But during the most recent inflationary shock period, the UK public sector net debt rose by 6 percentage points. Researchers said this was driven by government spending on household support introduced in 2022 to 2023, which cost £50 billion in that year alone, as well as the impact of higher inflation on the value of index-linked debt.
James Smith, research director at the Resolution Foundation, said: “Next week headline inflation should finally return to normal levels, marking the end of the UK’s biggest inflation surge in more than four decades. The sheer scale of this near three-year inflation shock has reshaped the economy and public finances, and changed what people do with their money.
“The crisis has made us poorer, with the sharp rise in the cost of essentials hitting lower-income families hardest. It has also turned us from a nation of spenders to a nation of savers, with credit card spending falling by 13 percent, and families saving around £54 billion a year more than we might have expected.
“While this high inflation phase may be largely behind us, its legacy will be felt well into the future, with national debt having increased, rather than being inflated away as we have seen in the past.”
