In December we had the wrong type of snow. Now it’s the wrong type of inflation, with the chancellor blaming bad borrowing figures on the type of price rises now hitting the UK economy. For consumers that all raises a basic question: what does it mean to say there’s more than one type of inflation, and is this type good or a bad for my household bills?
The answer depends on your income. Let’s start with the headline inflation story. CPI inflation rose from 4% in January to 4.4% in February. That means prices have now been rising at more than one percentage point above the government’s official target of 2% for 15 consecutive months. For policymakers it all feels like a rather tight squeeze. At one level, the combination of weak growth and above-target inflation presents the Bank of England’s monetary policy committee with an increasingly unenviable interest rate conundrum; at another, the current price rises increase the costs associated with pension and benefit up-rating and make spending cuts even deeper in real terms.
The reality for households is painfully stark. Bills have been rising much more quickly than incomes for 15 months – average weekly earnings growth stood at just 2.2% in January – and are expected to continue to do so until at least 2013. We are generally feeling poorer than we used to, even before the tax increases and spending cuts scheduled for 6 April.
But dig beneath these headline figures and it starts to become clear why some types of inflation can be worse than others for different types of household. That’s because, in basic terms, the CPI is an average, based on the “typical” basket of goods bought by UK households each year. As such, it masks very different trends in the costs of different commodities, a point well made by Comment is free reader Emma Chisset in a recent post.
Lately, inflation has been driven by above-average increases in the costs of staples such as food and fuel so, while the overall price level has increased by 12% since February 2007, the price of a loaf of bread has risen by 30%. Gas and electricity are up 23%, and petrol is up 49%. In contrast, the costs of many nonessential goods have risen much more slowly: clothing is down 16% (despite a more recent spike); cameras and camcorders are 36% cheaper than they used to be. Overall that averages out, based on the amount of each of those things we buy, to give the 4.4% figure we see reported.
But here’s the key point: it averages out differently for households on different incomes. If you’re on a lower income, you’re likely to spend a higher proportion of your money on essentials. As a result, you’ll have been harder hit by recent price rises: an annual inflation figure of 4.4% will significantly understate the price increases you’ll be facing. And this is not just a recent trend. Looking back over the last 10 years, if low-to-middle income households had faced the inflation levels that have been experienced by those in the top half of the income distribution, their annual bills would today be £150 a year lower than they are. Add in the fact that low-to-middle earners also typically experience slower-than-average wage growth and it becomes clear just who’s being hardest hit by 2011’s great squeeze on living standards.
All in all, then, the chancellor’s right to say there’s more than one type of inflation. But it’s not just the borrowing figures that are suffering: it’s millions of people living in low-to-middle income households.