Workers in the UK will see their earnings squeezed this year as consumer price inflation rises to 3.4% while wage growth stalls, according to the latest forecasts from the National Institute of Economic and Social Research (NIESR).
The private economic think tank warned that wage growth would peak at 2.7% this year, putting further pressure on households that are already grappling with council tax increases of 5%, higher energy bills and rising food bills.
Household spending stalls
Although NIESR believed the inflationary pressures to be temporary – due to slowing economic growth – British household spending is likely to have stalled by next year, it said.
Simon Kirby, head of macroeconomic modelling and forecasting at NIESR said: “GDP growth over the next couple of years will be subdued, growing at less than the economy's long-run potential rate of 2 per cent per annum, but households will feel the pinch from rising consumer price inflation.”
He added: “The rate of inflation is expected to rise from 2.3% in March to almost 3.5% by the end of 2017, and by 2018 we expect consumer spending growth to have effectively stalled.”
Bank of England
The projections by NIESR were several percentage points higher than the Bank of England’s forecasts, however.
In its last quarterly inflation report published in February, the Bank said it expected inflation to average 2.7% in the fourth quarter and peak at 2.8% in the second quarter of 2018.
A number of uncertainties persist that could upset all forecasts as the UK heads to the polls to select a new government on 8 June. It must then continue negotiations over Britain’s exit from the European Union.
Rate outlook clouded
This leaves the interest rate outlook clouded, said Howard Archer, chief European and UK economist at IHS Markit.
He continued: “Given major uncertainties over the UK economic outlook nothing can be ruled out on the interest rate front.”
If growth rebounded from the first-quarter slowdown, as suggested by purchasing manager surveys, the Bank could be prompted into raising rates later this year to cool inflation.
This would benefit savers, but mortgage holders already struggling with rising prices would be stretched further.
“Conversely, if the UK economy suffers a sustained major downward lurch as consumer spending is increasingly squeezed and the Brexit process develops, the Bank of England could very well react by trimming interest rates further,” added Mr Archer.
A rate cut would take some pressure off borrowers, but would do little to damp rising prices – although the pound’s recent gains will have gone some small way to tame inflation pressures.
The Bank of England publishes its latest quarterly inflation report on Thursday, 11 May, and also makes its call on interest rates.
Sterling, which hit historical lows against several rivals in the months following the EU referendum last year, has rebounded in recent months.
Although the pound remains nearly 15% lower against the dollar since the referendum, it has bounced 7% since mid-January and was up 0.2% on Tuesday to $1.2954.