UK inflation hitting 4% would inevitably ‘squeeze on consumer purchasing power’

Inflation in the UK will quadruple to around 4% in the second half of 2017, which would slash disposable income, according to a leading think tank.

Inflated prices of goods as a result of the falling pound against the dollar are expected to hit consumers in 2017, with the National Institute for Economic and Social Research (NIESR) warning that price hikes are inevitable as many companies, such as leading supermarkets, will struggle to absorb all the extra costs, as import expenses grow as a result of the significant fall in sterling’s value against major overseas currencies.

According to the Office for National Statistics (ONS), Consumer Price Index (CPI) inflation rose to 1% in September, up from 0.6% in August, and yet the price of many branded goods have already started to increase disproportionately since the vote to leave the European Union in June.

Many Heinz products, for instance, have reportedly soared in recent weeks, as have other popular branded goods provided by the likes of Kellogg’s, Coca-Cola and Pepsi. 

“Households have really got a choice. Do they spend less or do they start saving less?” Dr Angus Armstrong, director of macroeconomics at NIESR, told the BBC’s Today programme yesterday.

He said given the savings ratio was at its lowest level since 2008, “the most likely scenario is that they spend much less, hence the weaker [growth] forecast for next year”. 

With inflation almost certainly set to rise, the Bank of England could find itself in a position whereby it has no alternative but to raise interest rates even in a sluggish economy; the consequences could be bleak.

A combination of a weakening pound, increasing commodity prices, plus growth in wages would make for an uncomfortable mix of inflation, causing borrowing rates to increase which is bad news for homeowners.

Higher borrowing costs will push up mortgages rates and that could place downward pressure on house prices, which have been partly supported in recent times by abnormally low interest rates.

Higher interest rates will inevitably increase monthly mortgage payments for those who have not fixed their home loans, leaving some homeowners feeling poorer.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: “NIESR is right to warn that households are about to endure a renewed period of falling living standards due to soaring inflation.

“Fuel, food and technology prices already are rising in response to the weaker pound, and hefty price rises will be seen across the whole spectrum of consumer goods next year.”

Howard Archer, chief UK economist at IHS Markit, said inflation hitting 4% would result in “a major squeeze on consumer purchasing power”, which partly explains why he believes that UK home prices will fall by 3% next year.