Prolonged conflict in Ukraine could see a second inflation spike this autumn, reaching over ten per cent for poorest households

Rising food and energy prices risk driving a second inflation spike this autumn that could reach over ten per cent for poorer households – significantly higher than the peak for richer households – requiring the Chancellor to focus support in his upcoming Spring Statement on low-and-middle-income families hardest hit by the cost of living crisis, according to new research published today (Monday) by the Resolution Foundation.

Catch 2022 examines the UK’s rapidly evolving economic outlook ahead of the Spring Statement on Wednesday 23rd March, and how the Chancellor might respond to the challenges facing the country.

The report notes that the Chancellor is heading into the Spring Statement with good news on the public finances but terrible news on the family finances.

Borrowing for the current financial year (2021-22) is due to be £30 billion lower than forecast back in October, with tax revenues expected to come in £40 billion higher than forecast. This revenue-rich recovery is due to a wide range of factors, including a switch from self-employment to employee jobs and stronger wage growth, particularly among high earners who pay more tax on every extra pound they earn.

The outlook for the family finances is bleak however, and the report says that the conflict in Ukraine means there is heightened uncertainty around the UK’s economic outlook, with the only certainty being that it has deteriorated markedly.

The conflict will cause higher inflation – now likely to peak at over eight per cent – which will in turn will cause higher debt repayments for the Chancellor (up £30 billion across 2021-22 and 2022-23), and a deeper income squeeze (the typical family could see a fall of 4 per cent, or £1,000, in 2022-23).

The conflict is also likely to weaken GDP growth, and increase the probably of a recession. These concerns are clear in financial markets where a simple measure of the risk of a recession has risen to its highest level since just prior to the financial crisis.

A prolonged conflict in Ukraine would mean inflation being higher and longer lasting than previously forecast, with the drivers of inflation likely to shift over the course of the year, says the report.

While inflation is currently fairly evenly spread across the income distribution, that could change in the autumn as food price inflation (already two percentage points above its historic average) continues to build, and rising wholesale energy costs drive another sharp increase in the energy bill price cap in October.

With the poorest tenth of households spending twice the share of their family budgets on food and energy bills compared to the richest tenth of households, the second inflation spike of 2022 in the autumn could reach over ten per cent for these families.

The Foundation says this differential impact of the cost of living squeeze should inform how the Chancellor responds in his Spring Statement. For example, cancelling the upcoming increase in National Insurance contributions would be poorly targeted, as over half of the gains would go to the richest fifth of households. The typical tax gain for the poorest fifth of families would be just £60 – a tenth of the £600 loss from the current benefit uprating policy.

Instead, the Chancellor should revisit the uprating of benefits this April which, should inflation hit 8 per cent, would amount to a 5 per cent real-terms cut in the value of key benefits like Universal Credit and the State Pension.

The Chancellor should increase benefits by a further five percentage points this coming financial year, and then reduce uprating by the same amount the following year (2023-24) when inflation is expected to fall, says the Foundation.

James Smith, Research Director at the Resolution Foundation, said:

“Until recently, the Chancellor was approaching his upcoming Spring Statement with good news on the public finances and little pressure to make any big policy calls. Fast rising inflation, exacerbated by the conflict in Ukraine, has changed all this.

“The chances of a living standards recovery this year are receding as rapidly as inflation is rising, and the risk of another recession is looming into view. The Chancellor will therefore need to make some tough, and potentially expensive, choices in how to respond.

“The top priority should be to protect poorer households, who are most exposed to the biggest cost of living crisis Britain has faced in generations. This can be done by increasing benefits by 8 per cent, rather than 3.1 per cent as currently planned, in April. The Chancellor cannot protect Britain entirely from the difficult times that lie ahead, but he needs to act urgently to ensure the pain is fairly shared.”