Household disposable incomes will be squeezed for the next two years, the Bank of England has warned as inflation heads towards 7.25 per cent in April – the highest level since the early 1990s.
The central bank raised its key interest rate to 0.5 per cent on Thursday and trimmed its GDP forecast for 2022 to 3.75 per cent, down from the projected 5.0 per cent. This is despite a relatively rapid recovery from the impact of the Omicron variant of Covid-19.
Disposable incomes – the cash left after paying taxes and accounting for price rises – are set to shrink by 2 per cent this year alone, the worst hit in more than three decades of data.
It is worse than the squeeze in 2008 and 2011 in the aftermath of the financial crisis, and only the third time since 1990 in which disposable income has shrunk.
This pressure on household budgets will dampen consumer spending, and act as a handbrake on the pace of GDP growth which is expected to “slow to subdued rates” in the next few years averaging around just 1 per cent in 2023 and 2024.
Meanwhile, wage growth is set to continue to trail inflation, reaching just under 5 per cent by the end of the year before easing off as the labour market cools. Unemployment it set to rise to 5 per cent by 2024.
It comes as politicians scramble to address the cost-of-living crisis, amid soaring global prices, most particularly energy, have risen sharply in recent months.
The average household faces an increase in to energy bills of £693 to £1,971, according to Ofgem, the energy regulator which announced the new price cap to be introduced from April this year.
The chancellor, Rishi Sunak, announced a package of measures on Thursday in order to ease pressure on consumers from rising bills. However, the detail of these measures, which will result in around £350 being given to most households, was not baked into the Bank’s forecasts.
One reason the central bank expects GDP growth to be crimped is that higher prices will dampen consumers’ buying power. Still, the UK economy is expected to recover to it pre-pandemic level by the end of March.
But the impact of a sluggish economy will be felt in the labour market in the years ahead, the Bank of England said. While unemployment will drop back to pre-pandemic lows in the near term, it’s set to climb again as growth cools, reaching 5 per cent by 2024.
It will take around three years before inflation is within the central bank’s target range of 2 per cent, the Bank of England predicts.
Policymakers were split over how much to raise the Bank’s key interest rate. While five voted to increase the key interest rate by 0.25 percentage points to 0.5 per cent, four would have raised the key rate further, by 0.5 percentage points, to 0.75 per cent.
The rate setters also agreed to let a key economic support measure, quantitative easing, start to wind down by stopping its reinvestment in bonds.
