Soaring Inflation Means Britons Face Biggest Fall in Real Incomes in 30 Years

The BOE has nevertheless raised interest rates twice in the last three months and signaled there are more increases to come, delivering to hard-pressed Britons what Gov. Andrew Bailey has described as a “hard message”—that without rate rises, the economic pain from inflation would get even worse.

“We have not raised interest rates today because the economy is roaring away,” Mr. Bailey said Feb. 3 when explaining the latest increase. “We face a trade-off between strong inflation and weakening growth.”

The British economy expanded 7.5% for all of last year, according to data out Friday. However, by the end of 2021, growth had slowed considerably, with output falling by 0.2% in December compared with November, as the Omicron variant surged.

Meanwhile, annual inflation in the U.K. was 5.4% in December, and the BOE expects price growth to peak above 7% this spring, easily outstripping wage growth, which it expects to average 3.75% this year.

In the U.S., inflation is also surging, but the recovery from the pandemic is more advanced than it is in Britain. The U.K. only regained the ground lost to Covid-19 in November after its worst downturn in a century in 2020; the U.S. surpassed its pre-pandemic peak in the second quarter of last year. The Federal Reserve is expected to start raising short-term interest rates next month.

“Inflation in the U.S. is eroding real incomes at a time when demand growth is very strong,” said Robert Wood, U.K. economist at Bank of America. “In the U.K., it’s eroding real incomes when demand has not yet recovered to where it was two years ago.”

Supply-chain disruptions, rampant U.S. consumer demand for goods, and surging energy prices are driving up inflation across advanced economies. U.S. consumer prices rose 7.5% at an annual rate in January, a four-decade record.

While inflation in the U.S. has been fueled by stimulus that boosted consumer spending and broader economic growth, inflation in the U.K. has been driven in large part by surging energy costs and rising prices for imported goods.

The risk central banks are trying to head off by tightening policy is that high inflation stubbornly persists as people come to expect it and demand higher wages in return.

Mr. Bailey has faced criticism in the U.K. after urging workers to refrain from demanding inflation-busting pay rises that would fuel inflation. Four members of the BOE’s nine-member rate-setting panel voted in February for a bigger rate increase than the quarter of a percentage point finally agreed, reflecting concern that inflation is seeping into other parts of the economy.

“The needle they are trying to thread here is tightening enough to stop inflation getting ingrained but not so much that when you add it to the fall in spending power you create a downturn,” said Mr. Wood.

Economists expect inflation to fall back as energy prices level out, though it will remain around 5% into 2023.

For British households, a crunch point will be in April, when the U.K.’s energy regulator is due to raise a limit on what companies can charge consumers for gas, which is used to heat most homes in England and Wales and to fuel around a third of the U.K.’s electricity generation.

Wholesale gas prices have risen sharply in recent months. That means electricity and gas bills for a typical household will rise over the next year by £700—equivalent to around $949—an increase of 50% on 2021. In response, Treasury Chief

Rishi Sunak

announced support of £350 per household, more than half of which is effectively a loan.

Inflation has already wiped out a 6.6% increase in the minimum wage employers are mandated by the government to pay workers over the age of 23—billed by Mr. Sunak as a £1,000 pay rise for a full-time worker when he announced the budget last fall.

The government is also going ahead with a £12 billion tax rise in April, despite calls to wait until the cost of living crisis has eased—including from within the ruling Conservative party.

“It’s a double-pronged squeeze on people whose wages have not yet recovered to what they were in real terms before the global financial crisis,” said

Ann Pettifor,

an economist who recently gave evidence on inflation to Parliament’s treasury committee.

The squeeze is set to damp consumer spending for the rest of the year, slowing growth in the U.K. even as the impact of Omicron recedes.

Economists expect households to prop up spending by drawing on savings accumulated during the pandemic, but most of those are concentrated among higher-income families.

Lower income families—for whom energy bills form a larger share of spending—have little cushion to fall back on.

Referrals to food banks have already reached record highs, according to Citizens Advice, which offers assistance to people with legal, debt, housing and other problems. The number of people seeking advice on managing energy debts has also surged.

Billy McGranaghan has seen the hardships mounting from the community food bank in West London run by his charity Dad’s House. “We thought we had seen the worst of it during the lockdown and the pandemic,” he said.

Instead, the number of people relying on his food bank has increased, and now includes some who used to donate to it themselves.

As well as providing food, Dad’s House is now topping up gas meters for some of the worst hit such as Jennifer Cartledge, who has been struggling to support herself and six children between the ages of 3 and 15 on a budget of £2,000 a month.

She stopped working as a nanny during the lockdown and then separated from her husband, meaning she needed to stay at home to look after the children. They eat tinned beans and potatoes so she can afford to send her children on school trips. “You have to save every penny,” she said. “It’s getting harder.”

Write to Isabel Coles at [email protected] and Jason Douglas at [email protected]