Inflation and household spending
Rates of inflation are expected to increase sharply for all consumers in 2022, but since prices rises are expected to be especially high for energy and food, which make up a greater proportion of spending for lower income households, this group will experience a particularly high inflation rate.
We estimate that households with the lowest 40% of incomes will experience an inflation rate greater than 7% in April 2022.
For households with the lowest incomes, the share of household expenditure on just energy and food is predicted to increase by 3.1 percentage points to 28% of all spending. By contrast it will increase by 1.4 percentage point to 14.4% of all spending for households with the highest incomes.
The impact is expected to be particularly large for retired households and single parent households. In absolute terms, we estimate the increase in expenditure for these households to be £930 and £924 per year respectively compared to March 2020.
After a decade in which the UK’s rate of inflation has been more likely to under- rather than overshoot the Bank of England’s target, we are now experiencing bigger price rises. The inflation rate increased to 4.8% in December, the highest it has been since September 2008. The increase was a result of price increase across many categories of good services, but higher gas and electricity prices have commanded most attention.
With take-home pay and social welfare payments mostly not increasing at the same rate as prices, a cost of living squeeze has been widely anticipated and the Which? Consumer Insight tracker recorded a sharp increase in the incidence of financial difficulty in January. However, these living cost pressures won’t be felt equally across all households, in part because each household will have different spending habits and so their lived experience of inflation will vary.
In this article we draw together ONS data on the spending of families, official inflation data and predicted inflation rates to calculate measures of ‘lived inflation’ for different types of households and explore how they may be impacted by expected price rises.
Increasing inflation rates
The single largest contributor to the headline inflation rate in December was housing and household services. This was the result of sharply rising electricity and gas prices, driven by multiple factors including increased demand for energy as manufacturing has recovered from the pandemic, and reduced supply of non-renewable energy. Meanwhile, the largest contributor to the change in the inflation rate in December relative to November came from food and non-alcoholic beverages. Food prices are rising because of poor harvests, supply chain disruption and the increased costs of energy.
Prices are expected to rise further in the coming months, with the Bank of England predicting that inflation will remain around 5% before peaking at around 6% in April 2022. Higher energy prices will inevitably lead to higher prices for other goods over time, but more immediately there are concerns about household energy bills and food costs. Cornwall Insight has predicted a further rise by 50% in the energy price cap in April 2022 (compared to October 2021). Further food inflation is predicted to be driven by increasing commodity prices and energy prices with Capital Economics predicting a rise to 5% in early 2022.
Estimating ‘lived inflation’ rates
To estimate lived inflation rates for different types of households, we use the ONS’s Living Cost and Food Survey data to calculate the proportionate allocation of spending across expenditure categories that cover all spending except council tax by different households. We combine these with detailed price indices from the ONS to generate household-specific price indices by reweighting the price increases to account for differences in the proportion spent on expenditure categories.
Since inflation rates are only known to December 2021, to explore the impact of expected price rises we generate forecasts for inflation up to April 2022. To do this we use inflation predictions for energy from Cornwall Insight, and for food from Capital Economics. For all other expenditure categories we carry forward the latest level of inflation, December 2021.
The full methodology can be found here.
Comparing these inflation rates across households with different levels of income shows that inflation rates are expected to be highest for those on lower incomes. We estimate that the inflation rate in April 2022 for the first and second income quintiles, i.e. the 40% of households with the lowest incomes, will be 7.31% and 7.19%. This compares to 5.84% for the highest income quintile as shown in the chart below.
The burden of inflation falling more on those with the lowest incomes has not been typical of the UK’s recent experience. October 2021, when energy prices started to increase, was the first time in over 2 years that lower income quintiles had a higher modelled level of inflation than the highest income quintile.
This trend is expected to continue, shifting a higher burden onto lower income households, and to such an extent that we expect to see greater absolute differences between the income quintiles than we have observed in recent times.
In terms of household composition, we find that the overall rate of inflation is predicted to be highest for retired households and single parents with children. We estimate that the inflation rate in April 2022 for retired households and single parent households will be 7% and 6.7% respectively. This contrasts with 6.23% for single person households without children, see the chart below.
The impact on household budgets
Higher rates of inflation for lower income households are particularly problematic because these households will typically have tighter budgets and it is harder to avoid price rises on essential products.
The chart below shows the expected change in the proportion of household expenditure spent on food and energy by household income between March 2020 (the start of the pandemic), September 2021 (the month before the first sharp rise in energy prices) and April 2022 (when inflation is expected to peak).
The increase in the proportion spent on these categories is predicted to increase by 3.1 percentage points for those on the lowest incomes compared with a 1.4 percentage point increase for the highest income quintile.
This means that for households with the lowest 20% of incomes, averaging just £14,600 per year, 27.8% of their spending will be on just food, gas and electricity by April 2022. For those in the next lowest 20%, with average incomes of £24,000, this will be 24.5% of their spending. By comparison, for the 20% of households with the highest incomes, an average of £81,000 per year, this is estimated to be just 14.4%.
Looking at how this will impact on absolute levels of household expenditure, we estimate that those on the lowest incomes would be spending over £850 more per year on food, electricity and gas in April 2022 compared to March 2020 if they are unable to cut their consumption or find cheaper alternatives.
The figure below shows how households of different compositions are expected to be affected by these changes.
We find that single parents and retired households are expected to spend more than a fifth of their total expenditure on food, electricity and gas by April 2022. Not only did food and energy already account for a greater share of their expenditure for these households, but the increase in the share is also greatest for them.
In terms of actual expenditure, we estimate that a couple with children will spend over £1100 more per year from April 2022 compared with March 2020. For single parents the increase will be over £900 per year.
The expected upcoming price rises, particularly for energy and food, will lead to significant absolute increases in expenditure that will affect all consumers. However, since price rises are expected to be particularly steep for essential goods then this will have a disproportionate effect on lower income households, single parents and the retired. We predict that for those with the lowest incomes, more than 30% of their expenditure will be on energy and food alone in April 2022. By comparison, this is expected to be 15.5% among households with the highest incomes.
The forecast that most households will need to spend more than £900 more on food and energy in April 2022 than in March 2020 starkly illustrates the real impact of the cost of living squeeze. Unless households can be supported through measures that reduce these price rises or increase incomes, the effects of inflation will ripple through the economy in the form of reduced spending on other products and services and higher incidence of financial difficulty, such as more missed credit and bill payments.
If you have any questions or would like to find out more, please email Denise Lovett at firstname.lastname@example.org.
Published on 28.01.22
Note: small corrections made to proportional expenditure on energy and food by income group on 15.02.22.