UK households face largest fall in living standards in six decades

UK households are set to suffer a 7.1 per cent fall in living standards over the next two years, the largest decline in six decades, according to new forecasts from the Office for Budget Responsibility.

Surging inflation, rising mortgage costs, falling property prices and higher unemployment are battering household finances, with the OBR projecting that real disposable income will fall by 4.3 per cent in the 2022-23 fiscal year, the biggest drop since records began in 1956-57.

This would be followed by the second largest fall on record, at 2.8 per cent, in 2023-24, taking the cumulative hit to 7.1 per cent, it said.

Richard Hughes, the OBR’s chair, said the falls would “wipe out the last eight years of improvement” in living standards, with people’s incomes remaining more than 1 per cent below pre-pandemic levels even at the end of 2027-28.

Economic output, meanwhile, was expected still to be below its pre-pandemic peak by the end of the current election cycle in 2024.

The slump will coincide with a tapering of the government’s support for households’ energy bills and its lump sum payments to poorer households, although it has confirmed a commitment to raise benefits in line with inflation. This fiscal support tempers the hit to households and limits the scale of the recession the UK faces over the next two years, with tax increases biting harder later on.

Meanwhile, a tight labour market means unemployment is set to rise less than typically in a recession, peaking at 4.9 per cent midway through 2024 — although this is still equivalent to half a million job losses.

The OBR said the government’s energy price guarantee, combined with the various cost of living support packages announced since March, had reduced the hit to household incomes over the two-year period by about a quarter, while also limiting the economy’s contraction.

But it still believes the economy has already entered a punishing recession that will last for more than a year, with a peak-to trough fall in output of 2.1 per cent starting from mid-2022. Hughes said this meant a downturn “similar in depth to that seen in the recession of the 1990s”, although much shallower than those caused by the pandemic and the 2008 financial crisis.

In a huge downgrade from its March forecasts, the OBR expects the economy to shrink by 1.4 per cent in 2023 — lowered from an estimate of 1.8 per cent growth — and expand only by a feeble 1.3 per cent in 2024.

Jeremy Hunt, chancellor, said the OBR had laid out the “stark impact of global headwinds on the UK economy” and that its forecasts showed the government was helping to make the recession shallower, inflation lower and job losses smaller than would otherwise be the case.

But George Dibb, head of the Centre for Economic Justice at the think-tank IPPR, said the UK was the only G7 economy that had yet to regain its pre-pandemic size and, despite the chancellor’s promises of growth, “the OBR forecasts show another half decade of economic stagnation ahead”.

Soaring prices are by far the biggest factor hitting household incomes in the short term. Although the OBR thinks November’s 11.1 per cent reading for consumer price inflation represents the peak, it expects inflation to remain high into next year, averaging 7.4 per cent in 2023. Based on market expectations of higher interest rates and a sharp fall in gas prices, inflation would then fall rapidly with consumer prices falling outright for a full two years from mid 2024.

But, even as price pressures waned, the OBR said households would increasingly feel the effects of frozen tax thresholds, higher mortgage costs and a fall in property prices of some 9 per cent over two years — and would cut their spending sharply as a result.

It is predicting a slightly stronger recovery than the Bank of England expects in 2024 chiefly because it is more optimistic about inflation falling fast and because it thinks some people who amassed big savings piles during coronavirus lockdowns will now run them down to protect their living standards — with the saving ratio falling to zero in 2023.

Even worse than the outlook for household consumption is the OBR’s forecast for business investment, which is already 8 per cent below its pre-pandemic level and expected to fall further in 2023. The OBR said recession, higher interest rates and energy costs, the corporation tax rise and uncertainty over the UK tax regime would all contribute to keep investment 8.8 per cent lower than its March forecast at the start of 2027.

Torsten Bell, director of the Resolution Foundation think-tank, called this a “disaster”.

“Investment today is our living standards tomorrow,” Bell said.

The OBR also said near-term growth in both exports and imports would be lower than it forecast in March because of the weaker growth outlook. Its trade forecast reflected evidence that Brexit had had “a significant adverse impact on UK trade”.

Yet despite the deterioration in the outlook for the economy over the next five years, the OBR has not changed its view since March on the UK’s capacity to grow annually in the longer term.

This optimism came as the OBR shifted its view on the likely effects of the post-Brexit migration regime, expecting more foreign workers to arrive, boosting the size of the UK workforce and compensating for weak business investment and productivity.

Source: Economy - ft.com