The cost of living in 2022 – what does it mean for households

The cost of living squeeze is tightening. Rising prices are hitting our wallets, product shortages are leaving gaps on the shelves, and a labour crunch is pushing up wages. In fact, inflation in the UK reached a 30-year high in December, rising to 5.4%. 

Although the Bank of England (BoE) still thinks higher prices won’t be here to stay, it’s raised its expectations for peak inflation – and pushed it back. In August the forecast was for a peak of around 4% at the back end of this year. But by November the BoE expected inflation to hit 5% in April 2022. Unfortunately, even this more pessimistic forecast has already been met, and it now expects inflation to hit 6% this spring.

It seems the Omicron wave will have a relatively limited impact on the economy compared to previous waves, though uncertainty still abounds.

This article isn’t personal advice. If you’re not sure what’s right for your circumstances, please seek financial advice.

Supply chains

Gaps on shelves have become a regular occurrence over the last year or so, which has brought the reality of supply chain disruption into view for many.

Supply chains all over the world have snarled up as we’ve recovered from the initial shock of the coronavirus pandemic. That’s left businesses unable to get a ready supply of goods, pushing up prices.

Demand had cratered in the early stages of the pandemic as people stopped spending as much. At the same time, supply was interrupted by social distancing measures used to fight the virus. Then, as we were all stuck at home, demand shifted to reflect our more sedentary lifestyle.

This can be seen in the computer chip shortage. As we bought fewer cars and more laptops when lockdowns began, supply chains adjusted to reflect this. However, now that people want cars again, there aren’t enough chips to go round. That’s sent used car prices soaring and is putting pressure on everything from cars to gaming consoles. Fortunately, there are some signs this particular shortage will ease in the coming months, but chips are just one of the many supply chains feeling the strain.

The knock-on effect of high demand but short supply are many and varied – and demand bespoke solutions, rather than quick fixes. A good example of this is the port at Long Beach, California, which is usually one of the busiest in the world. Container ships were sitting around in the sea, unable to unload because there wasn’t enough space on the docks to store the containers.

Part of the problem turned out to be a law that said you could not stack containers more than two high, severely limiting available space. This law might have made sense when there was a lot of slack in the supply chain, but it was contributing to a severe bottleneck now that conditions were tighter. Fortunately, the problem was recognised. The height limit was raised, but it’s not a general solution that can be rolled out elsewhere.

The other issues affecting supply chains is the labour shortages and these are more acute in some countries than others. Here in the UK, the HGV driver shortage has been particularly thorny. That’s partly because so many European drivers returned home during the pandemic following the Brexit vote, and visa restrictions mean it’s now harder to recruit from abroad.

These supply chain problems should get worked out eventually, but it remains to be seen how long it will take.

Retail sales

Retail sales are an important measure of the health of the economy as they’re an indicator of what economists like to call consumer confidence. If people feel their personal financial situation is relatively rosy, they’ll be more likely to splash their cash in the shops. When measured across the economy as a whole, retail sales can help build a clearer picture of the general state of the country’s household finances.

In December, the arrival of the Omicron variant interrupted the retail recovery for high street stores. As more shoppers stayed away, hunkering down for more muted celebrations at home, tills were quieter and volumes lower. Department stores, fashion chains, toy retailers and other non-food stores saw sales plummet, by 7.1% overall.

But given that shoppers had already been out in force in November ticking off gifts from Christmas lists, this could also partly account for the fall.

Although ONS data showed footfall rising again in mid-January, it was only by a meagre 2%, and followed three consecutive weeks of falls. Overall retail footfall remains 79% of 2019 levels.

Hybrid working is fast becoming the norm and household budgets are tightening. That means even as ‘Plan B’ restrictions lift, the number of shoppers is unlikely to snap back to pre-pandemic times in high streets and city centre locations.

Two thirds of adults have already reported the cost of living has increased. With more energy price rises on the way, there are likely to be far fewer shoppers merrily splashing the cash in the months to come. That could limit price rises, with retailers more likely to try and keep prices lower to entice customers in.

Energy prices

While energy only accounts for a small part of direct household costs, they are volatile and therefore are often a disproportionate driver of inflation. This has certainly been true recently. In fact, the Bank of England has been going to great lengths to stress that the future path of inflation will be heavily dependent on energy prices.

In the UK, household energy bills are subject to a price cap set by Ofgem which is updated every six months. In October, the cap was raised by 17% on gas and 9% on electricity, reflecting higher wholesale prices. The Bank expects these to rise further in April, but costs should moderate in the medium term if future curves are to be believed.

The other big energy sector is oil. The global oil market did stabilise after crashing at the start of the pandemic. Inventories rose as demand collapsed when lockdowns first went into force, leading to large production cuts thanks to the Declaration of Cooperation between OPEC and its peers. Now, prices are stronger and inventories have normalised. Concerns about the new Omicron variant have led to concerns about lower global demand which weakened prices a little initially. But prices have since largely recovered.

Unfortunately, as Russia manoeuvres more troops to the Ukraine border, concerns about the escalation of tensions are already causing fresh volatility in energy markets. Russian gas exports could be targeted with sanctions if Putin invades, which could push up the price of wholesale gas again. 

But if conflict does break out, it’s likely to cause a wave of unease across financial markets. Investors could scurry away from more risky assets and take shelter in less risky assets like government bonds, gold and defensive stocks like consumer goods, healthcare and utilities.

The UK has also said it’s considering all options in how to respond if Moscow invades Ukraine, including economic sanctions. If tensions are calmed, we’re still likely to see wholesale gas prices stay elevated, given the structural shortage in gas markets. Developing major new gas projects is an expensive and time-consuming process and there’s likely to be high demand for gas as a vital transition fuel as we move toward a lower carbon energy mix. 

What if the problem is demand?

Inflation has several potential drivers, and among them are the balance of supply and demand. All else held equal, if demand outstrips supply, prices will rise, and vice versa. This could be because supply has been interrupted, as we’ve discussed above, or because demand has risen, or a combination of both.

The overall level of demand in the economy is driven by several factors, including the health of household finances, the availability of credit and government spending. Some economists are worried that demand might have been raised to a level that the economy can’t satisfy. That’s mainly because of huge government spending to combat the pandemic, combined with central banks printing massive amounts of money, and stronger than expected household finances.

If this is what’s happened, inflationary pressure is likely to stick around for longer than currently forecast. Even if the supply problems get worked out, the global economy just won’t be producing enough stuff. Unfortunately, fixing this will require central banks to tighten policy more than currently anticipated. This could put a dampener on economic growth and potentially lead to an increase in unemployment.

This isn’t the mainstream view though, but it’s worth bearing in mind dissenting opinions to avoid being caught unawares.

So what does this mean for households?

Prices look like set to keep rising well into next year, and pay growth is currently struggling to keep up despite a large number of vacancies. Rising prices will also make shopping around for the best deal more important than ever, especially if energy bills continue to rise.

And finally, when inflation is above 5% and interest rates on most savings accounts are a fraction of that, cash savings will be losing their value. Holding some cash for safety is important, but remember that there’s a cost to that. The BoE does expect to raise interest rates in the next year or so though, so if inflation comes down, that could change.

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