How Bad Will the Cost of Living Squeeze Get?

UK Policy Prosperity

How Bad Will the Cost of Living Squeeze Get?

Commentary
Posted on: 11th August 2022
By Multiple Authors
Ian Mulheirn
Executive Director for UK Policy and Chief Economist
James Browne
Head of Work, Income and Inequality Analysis

If, earlier this week, anyone was in any doubt about the severity of the looming cost of living shock this winter, they shouldn’t be any longer. Projections for the home energy price cap have risen substantially since Chancellor Rishi Sunak announced his third support package in May. The outlook for January and April next year is even worse. This is set to put huge pressure on households, millions of whom will simply not be able to afford these amounts. How bad will it get and what kind of fiscal response would cushion the blow?

In the wake of Sunak’s package of measures back in May, the poorest households were expected to be no worse off over the course of the financial year, even though the price cap was expected to hit £2,800 in October.

But since then the anticipated level of the energy price cap in October has continued to rise at an alarming rate. Cornwall Insights now expect it to hit £3,582 in the final quarter of the year, £4,266 in January and £4,426 in April next year. For millions of households these are simply not feasible sums of money for them to find. Nor is the energy price shock the only part of the cost of living squeeze, with wider inflation surging.

Putting all of this together, and drawing upon Oxford Economics’ latest inflation forecasts, we find that households in the lower half of the income distribution can now expect the cost of the goods and services they consume to be £120 higher from October.

Some more help is already on the way with six monthly instalments of £67 being rolled out to all households from October. But lower income households still face being more than £50 a month, or over 3%, worse off than they are today in the final quarter of the year, while the average household will be nearly £90 poorer each month. Workless families with children will be hardest hit, seeing a £70 or nearly 4% fall in their monthly purchasing power. The flat rate increase in benefits and energy bill support announced in May represents a smaller percentage increase in income for this group than for other benefit claimants.

Figure 1: Poorer households set to be £50 a month worse off in October

Note: since households receiving means-tested benefits are already receiving the additional £650 payments announced in May, these do not appear in the chart as an increase in household incomes in October.

Source: TBI calculations using Cornwall Insights energy price forecast, Oxford Economics inflation forecasts, ONS Family Expenditure Workbook and UKMOD version 3.5 run on the 2019–20 Family Resources Survey. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The results and their interpretation are the sole responsibility of TBI.

Liz Truss has suggested that further ‘handouts’ aren’t the answer. Instead, she has proposed reversing the NICs increase, designed to fund health and social care, to help ease the crisis. That offsets a large chunk of the October price shock for well-off households. But it does very little for those who are most exposed to this price shock. With a NICs cut households in the bottom half of incomes will still be on average more than £50 a month worse off. Reversing the NICs rise therefore won’t do anything to help the people for whom bills at these levels will be well beyond anything they can afford to pay. For the poorest tenth of households the tax cut would help them by just 76p per month on average, whereas the richest households in the UK will be better off by £93 a month. Similarly, Sunak has indicated that he would cut VAT on fuel. But for the typical household this would only amount to a saving of around £14 per month.

Figure 2: Reversing the April NICs rise won't do much to help poorer households

Source: TBI calculations using Cornwall Insights energy price forecast, Oxford Economics inflation forecasts, ONS Family Expenditure Workbook and UKMOD version 3.5 run on the 2019–20 Family Resources Survey. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The results and their interpretation are the sole responsibility of TBI.

And that’s just October. With further significant increases in energy prices in January and April, the squeeze will worsen just as the government’s existing support package comes to an end. While benefits will be uprated in April in line with this September’s inflation rate, expected to be around 10%, that won’t go very far as other support falls away.

So compared to now, the outlook is set to deteriorate sharply over the next 8 months in spite of the support on offer later this year. By April, millions of poorer households are set to see a hole in their finances of 10% or more of their income.

Figure 3: As energy bills soar and support falls away, household finances are set to worsen quickly

Source: TBI calculations using Cornwall Insights energy price forecast, Oxford Economics inflation forecasts, ONS Family Expenditure Workbook and UKMOD version 3.5 run on the 2019–20 Family Resources Survey. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The results and their interpretation are the sole responsibility of TBI.

Cutting NICs or VAT on fuel doesn’t cut it. What might? To offset the cost of living squeeze for low-income households, the obvious policy response would be to expand and extend the measures Rishi Sunak announced in May.

An additional £325 payment to those on means-tested benefits, on top of the two that will already have been paid by October – equivalent to £54 a month until the end of the fiscal year – would address the October shock for benefit claimants at a cost of £2½ billion.

Come April, as this years support ends, a much larger package will be needed. Boosting benefit entitlements by £1,000 next year (equivalent to £83 a month) and extending the univeral £67 per month support towards energy bills next year would fully protect benefit claimants, as well as limiting losses for those on average incomes and above, at a cost of £30bn for the year.

Figure 4: Expanding and extending the existing support package could limit the pain

Source: TBI calculations using Cornwall Insights energy price forecast, Oxford Economics inflation forecasts, ONS Family Expenditure Workbook and UKMOD version 3.5 run on the 2019–20 Family Resources Survey. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The results and their interpretation are the sole responsibility of TBI.

But to be most effective, a new support package must be the first part of a more strategic policy response. With energy prices set to remain high for the foreseeable future, we need a predictable framework for how the Treasury will support households as energy prices fluctuate next year and beyond. Critically, that framework must also involve the government putting its weight behind more rapid home decarbonisation as the only long-term solution to cutting the cost of living.

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