Household finances under renewed pressure as UK inflation remains high

Higher prices continue to erode UK household budgets with the official measure of inflation still well north of 3%. UK CPI was an annual 3.4% in May, having jumped to around that level in April from 2.6% in March thanks to a wave of household bill increases – by Rob Morgan

It was the usual suspects contributing to the annual rate: Higher energy, water and council tax bills and increasing contract charges from the start of the new financial year. On top of this the hike in National Insurance and minimum wages kicked in for employers from April, with many companies choosing to pass these extra costs onto customers, creating a perfect storm for price rises.

Inflation in services, which is typically sensitive to labour costs, did moderate to an annual 4.7% from 5.4%, although there was a notable monthly increase of 0.8% in restaurants and hotels. Elsewhere, prices in areas such as food, clothing and household goods offset a fall in transport costs.

Moving forward, inflation is expected to ease further, and it seems the UK will be spared significant upward pressure on prices owing to the Israel-Iran conflict, which has seen oil prices surge then fall back. A further escalation could cause problems, though, so it’s a factor to keep an eye on.

What does it mean for households?

Household finances are under renewed strain. Although average wages have been trending higher, mounting expenditure on bills and groceries, plus higher mortgage costs for many thanks to higher interest rates, means extra income is typically spent on essentials rather than saved.

Hopefully, better news lies ahead. While services inflation in particular stands to remain elevated in the short term thanks to increased employer costs, it is a factor that should fade as the months roll by as companies scale back hiring and restrain pay where possible.

Economic weakness also stands to keep price rises in check and allow the Bank of England more room to lower interest rates and offer breathing space to households and businesses. The 0.3% fall in UK GDP in April unwound much of the expansion in the first quarter and is perhaps a prelude to a stagnant remainder of the year.

However, a slow economy that heralds lower inflation brings a different set of problems. Job losses are spreading across key sectors like hospitality, construction, tech, and professional services. A signal for households to take a more cautious view of the employment market and build some cash for leaner times if possible.

What does it mean for interest rates?

While the Bank of England under pressure to ease rates the inflation data is not sending obvious signals to do so. The door is still open to a summer rate cut but sticky price rises could yet slam it shut.

In the near term, the BoE is expected to keep interest rates on hold this week at 4.25%. Despite some distress signals from the labour market, leading to lower expectations for future wage growth, that metric is so far inconsistent with the BoE’s 2% inflation target at over 5%.

Vanquishing inflationary forces is complicated. The BoE has been in a dilemma for some time about whether it places more emphasis on deteriorating labour market trends and the lacklustre growth picture, or on possible engrained wage rises that stand to stoke the inflationary embers. Presently, it seems the economy is strong enough for companies to pass on higher employment costs and the inflationary momentum continues. But their ability to do so hangs in the balance with the growth in the economy, or lack of it, the crucial factor. An August rate cut is very possible, but it’s far from nailed on.

Rob Morgan is Chief Investment Analyst at Charles Stanley