2022 has been a year of highs, but the high in this regard is inflation. The prices of goods and foodstuff have been skyrocketing at an alarming rate. This has directly had an impact on the cost of living of UK citizens and beyond. Inflation is determined by how much goods and services have increased over a given period.
To better explain how inflation works. When you say there has been an inflation rate of 7%, it means that the prices of goods and services is 7% more expensive than in the past year.
This means the cost of living is directly impacted by an increase in the inflation rate.
The Bank of England on May 5 forecasted the highest inflation in the country since 1982 will happen by Q4 2022. They forecasted that the inflation rate will peak by slightly over 10%. They projected that inflation will be at about 9% in Q1 2023, before reducing to 3.6% by the end of 2023 and below 2% in 2024.
1. Relationship between the cost of living and inflation
Cost of living is the amount needed to maintain a standard of living. Though inflation directly impacts your cost of living, it is not the only variable affecting it. Another variable that affects the cost of living is how expensive a particular area is.
Factors like rent cost, house cost, healthcare, taxes and transport also play a hand in changes in the cost of living. For example, living in a city like London is more expensive than in Hereford, West Midlands and Derry, Northern Ireland.
Some unexpected chain of events can also affect the cost of living in a particular area. During the Covid-19 pandemic, for example, more people had decreased the cost of living because they didn’t have to commute to work.
In an instance where global warming becomes extreme, people in cold countries won’t have to worry about heating anymore. This will reduce the amount they spend.
People in hotter countries might have to invest in air-conditioning. This will increase the cost of living in this region.
2. Drivers of Inflation
In 2022, there have been three main drivers of consumer price inflation. They are
- Food and non-alcoholic beverages
- Housing, electricity, water and similar bills
These three drivers account for more than 50% of the Consumer Price Index.
In May 2022, Consumer Prices were 9.1% higher than in the same period in 2021.
Since April 2022, the Ofgem price cap rise has been directly responsible for the increase in “housing, water, electricity, gas and other fuels”.
Between April and May 2022 alone, the price of this driver increased by over 46%, with a further increment experienced in May.
Motor fuels have played a big part in the high cost of transport in recent months. The annual growth rates for petrol and diesel reached 32.8% in May 2022. This was the highest rate ever recorded since the inception of consumer price inflation in January 1989.
Energy prices, including household tariffs and petrol costs, have also played a role. Between May 2021 and the same period in 2022, there has been a domestic gas price growth of 95%. Domestic electricity prices have also gone up by 54% during this period.
Another factor that affects the cost of living through inflation is political conflicts. An example is how much Russia’s invasion of Ukraine has affected the world’s economy.
The warring countries, Russia and Ukraine happen to be one of the largest producers and exporters of agricultural goods like wheat and metals.
These conflicts and sanctions put on a country like Russia mean these products cost more on international markets.
This has led to an increase in food and material prices in countries like the UK.
3. Inflation vs real wages
When talking about inflation, it is important to take income into account. What then is the relationship between income and inflation?
If your income is higher than the inflation rate, you will have less to worry about in terms of the cost of living. But if income isn’t increasing at the same pace as inflation then it becomes a problem.
For example, imagine we have an inflation rate of 6%, but the average income also increased by 9%, then the real income would have increased by +3%. This means that inflation has increased but the cost of living won’t affect the family much.
4. Why the cost of living may rise more than inflation
Energy, transport and food have been the main drivers of consumer price inflation. The problem with this is that these drivers are essential expenses for most households and can’t be done without.
Yes, ways of reducing how much they take up from your income can be found but it has its limits. Higher-income households have an advantage here as they can swap their non-essential spending to cover these necessities.
Not many small-income households have that opportunity.
It is very possible to have a case whereby the cost of living becomes higher than the inflation rate.
Inflation is the measure of the purchasing power of money in an economy. The same is through for households.
A low-income family may spend much of their income on basic food items, rent and fuel for example. The cost of living for these families would easily be higher than inflation if the cost of these essentials increases at a faster pace than inflation.
The cost of living has been increasing faster than inflation for some basic essentials. Jack Monroe, a food campaigner said basic foods rose higher than the official inflation rate between 2021 and 2022.
However, this year, higher-income households have experienced higher inflation rates than low-income families. The reasons for this are simple.
Higher-income households tend to spend more to maintain their standard of living. This means spending more on transportation as they use personal cars instead of the public transport system.
The consequence here is spending more on fuel as the price of motor fuels has drastically increased over the past year.
Other areas higher-income households are spending more on are energy, recreation, hotels, restaurants, and lifestyle.
5. How Government policies are helping
The Chancellor announced measures taken to support households in February, March, and May 2022. The support was estimated at £37 billion and includes:
- Given a £400 relief off energy bills for households
- Households receiving means-tested benefits were given £650 plus a £300 payment for pensioners and people receiving disability payments were given £150
- Giving a 5p cut to fuel duty
- Households in council tax band A-D were given a £150 tax rebate
- The threshold at which NICs charged on earnings was increased
Both National Insurance contributions (NICs) and income tax experienced tax rises by the Government in April 2022. The net level of government during this period is estimated to reach about £14 billion in 2022/23 when the changes are included.
In May 2022, 88% of adults in Great Britain experienced a rise in their cost of living, according to the office of the National Statistics.
Office for Budget Responsibility (OBR) in its March 2022 forecast suggested that household income taxes after tax and adjusted for inflation to begin lowering in Q2 2022 will not recover till Q3 2024.
Since lower-income families spend more of their income on energy, food, and transport, they are expected to be affected more by the changes in the cost of living. That is why the recent Government support for households was created around benefiting lower-income households the most.
According to the Resolution Foundation, the measures in place by the Government to support households will remove 82% of the rise in households’ energy costs in 2022-2023. This number is expected to increase to over 90% for poorer households.
Low-income households spend a larger proportion than average on energy and food so will be more affected by price increases. Overall, recent Government support for households benefits low-income households the most.
The Resolution Foundation estimate that the measures announced to support households this year will “in effect offset 82 per cent of the rise in households’ energy costs in 2022-23, rising to over 90 per cent for poorer households”.
Shrinkflation knock-on effect of inflation
When inflation happens, companies and brands tend to compensate for the lower purchasing power of customers with shrinkflation. Companies intentionally reduce the size of their products so it is still affordable for all.