Households face squeeze from inflation and flat wages

Britain faces a double squeeze on living standards as two decades of stagnating wages and spiralling inflation conspire against household finances, experts warned after Rishi Sunak’s big-spending Budget.

Inflation is expected to reach 4.4 per cent next year, fuelled by post-pandemic supply chain shocks and soaring energy prices, the Office for Budget Responsibility warned. The Consumer Price Index could climb to 5.4 per cent, the highest level since March 1992.

Rising prices will add to the pressure on families caused by flatlining wages. The Institute for Fiscal Studies predicts that disposable incomes will grow by just 0.8 per cent per year over the next five years, “well below the historical average”.
The OBR forecasts mean that average real wages will be lower than in 2008 by 2026 as higher inflation bites, the IFS added.

The OBR, the fiscal watchdog, also forecast that in two years’ time homeowners face the biggest percentage increase in mortgage interest payments since the financial crisis.

In 2023, the interest component of mortgage repayments is expected to rise by 13 per cent year-on-year, a jump not seen this side of the housing crash in 2008.

The increase would mean paying an extra £300 a year for a homeowner of an average-price house (£264,245) with a 25-year, 80 per cent loan-to-value mortgage and a current 2 per cent interest rate. The OBR expects the Bank of England to raise the Bank Rate from 0.1 per cent now to 0.75 per cent by the end of 2023.

Higher mortgage repayments will be caused by increased interest rates charged by lenders and house price growth in the coming two years.

Homeowners who locked into cheap mortgage rates this summer on a two-year fixed deal could find themselves paying hundreds of pounds more in repayments each year when they are re-financed on to higher rates in 2023.

While the year-on-year increase in mortgage interest payments will average 13 per cent across 2023, it will peak at 14.8 per cent in the second quarter of that year.

By comparison, the year-on-year increase predicted for the final quarter of 2021 sits at 0.2 per cent.

Duncan Lamont, of asset manager Schroders, said a 15 per cent rise was “unprecedented” and warned it would serve a “real shock” to borrowers. The average mortgage rate sits at 2 per cent, according to the OBR, but will have increased to 2.2 per cent by the end of next year and 2.4 per cent towards the end of 2023.

The IFS said that, combined with a weak decade of growth before Covid-19, average disposable incomes will stand 28 per cent below pre-financial crisis trends in five years’ time.

By 2026, real wages will be £9,000 per year short of where they would be if they had continued to grow at their rate before the financial crisis.

Paul Johnson, the IFS’s director, added that take-home pay for the average earner will fall by around 1pc or £180 a year in real terms as inflation takes a “significant swipe” out of incomes and tax rises loom in April. He added: “Large swathes of the population face a squeeze on living standards over the coming year.”

The OBR warned inflation would hit household incomes until late 2023 and added that a 20pc rise in oil prices and a 50pc rise in wholesale gas costs since the watchdog completed its forecasts could mean even higher inflation of “close to 5pc”, it added.

The Bank insists the spike will be temporary, but the OBR added that more persistent pressure driven by energy costs and wage demands could push the CPI all the way to 5.4pc, a level not seen for 29 years. Under the OBR’s main scenario, inflation will stay above the Bank’s 2pc target until at least 2024.

'Inflation is eating away at nominal wages'

Richard Hughes, the OBR chairman, said: “Real household disposable income per capita is not recovering to its pre-Covid level until the second half of 2023, so you are seeing stagnation in household disposable incomes over the next few years.

“Most of that is inflation. Some of it is taxes and benefits, but the lion’s share is the fact that inflation is eating away at nominal wages over the next few years.”

The inflation squeeze overshadowed predictions of the fastest spurt for the British economy this year since the “Barber Boom” in 1973 as the OBR forecast growth of 6.5pc, clawing back the ground lost to the pandemic by the turn of the year, six months earlier than previously thought.

Financial markets are also betting on the first rate rise from the Bank in three years next week amid increasing nerves among policymakers over inflation, adding to the pressure on households with variable rate mortgages.

Silvia Dall’Angelo, senior economist at Federated Hermes, said: “The convergence of high inflation squeezing real incomes, together with monetary and fiscal tightening, has the potential to derail the recovery, against a backdrop of lingering uncertainty about the evolution of the pandemic.”

While the OBR said stronger growth and inflation would lift the Treasury’s tax receipts by around £50bn a year, it also adds to the Government’s debt interest bill. About £500bn of the UK’s borrowing is linked to the Retail Prices Index, triggering an extra £24.1bn in interest payments owing to the inflation spike by March 2023.

Mr Sunak said the pressures caused by supply chains and energy prices “will take months to address”.

“It would be irresponsible for anyone to pretend that we can solve this overnight. I’m in regular communication with finance ministers around the world and it’s clear these are shared global problems – neither unique to the UK, nor possible for us to address on our own.”

Opposition politicians last night seized on the forecast of a major mortgage interest payment hike awaiting homeowners in 2023.

Lib Dem leader Sir Ed Davey accused the Chancellor of creating “the perfect storm”, as families face a “toxic cocktail of interest rate rises, house prices surges, and council tax hikes just around the corner”.

It is the “worst time in a generation to be a homeowner”, Sir Ed claimed.