UK: Economic Review - Q2 2011

Feeling the pinch

In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, turns his attention to the intense squeeze on consumers and their incomes. He thinks that the situation will get worse before it gets better. But better times do lie further ahead. His main points are as follows:

  • Households are already suffering the biggest squeeze on their incomes in decades. But the worst may be yet to come.
  • For a start, pay growth is unlikely to catch up with inflation any time soon. Inflation is heading towards – and possibly above – 5%. And while pay settlements have begun to increase, I doubt that they will rise much further when unemployment is still high and the public sector faces a pay freeze.
  • I expect real earnings to fall by about 1.5% this year. This will mark the fourth successive year of falling real earnings – the first time that this has occurred since the 1870s.
  • An additional reason to be pessimistic about the outlook for household incomes is the deepening fiscal squeeze.
  • Admittedly, there have been some not insignificant tax giveaways, including the rise in the personal tax allowance. However, the net effect of this year's direct tax changes will still be to reduce household incomes. And it gets worse next year, when the Office for Budget Responsibility (OBR) expects receipts from income tax and national insurance contributions to rise by some 8% – compared to total earnings growth of just 3%.
  • Lastly, the labour market outlook provides further cause for concern. I still doubt that the private sector can compensate for the cuts in public sector employment – which is already falling by 100,000 a year.
  • The upshot is that I expect households' disposable incomes to fall by 2% this year in real terms – equivalent to about £780 per household. And it will take until 2015 or so for incomes to get back to their peak in 2009.
  • Some forecasters – such as the OBR – are optimistic about the ability of households to run down their saving to support their spending. But the saving rate is historically low and, in the medium-term at least, needs to rise.
  • I have been warning for some time of the difficult period that households were about to face and so already expected consumer spending to fall. But given the additional pressure from the further rise in inflation, I have revised my forecast for this year's fall in spending from 0.5% to 1%. I now expect spending to fall further in 2012, by 0.5% or so.
  • Of course, not all households will be affected equally. Attention has focused on the "squeezed middle," but I am not convinced that middle income households will be any worse affected than the poorest or richest households. The big picture is that pretty much all households face a further squeeze over the next year or two.
  • At least more favourable conditions lie further ahead. I think that inflation could be well below target by the end of 2012, allowing real incomes to start rising again. And by the end of this Parliament, taxes could be falling rather than rising. But for those households struggling to make ends meet, that may still seem an age away.

For further information, please download our full report 'Economic Review: Feeling the pinch'. (PDF)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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