Inflation hits 2.9 per cent, squeezing households further

Wage growth remains lower than inflation, which means households have less money

Inflation has hit a new high at 2.9 per cent in August, up from 2.6 per cent in July, according to the Office for National Statistics (ONS).

The Consumer Prices Index (CPI), which measures inflation, therefore remains well above the Bank of England’s 2 per cent inflation target.

Rising prices for clothing and motor fuel were the main contributors to the increase in inflation between July and August.

This change in inflation means that each UK household will need to spend an extra £797 on average a year to maintain their standard of living compared to a year ago, according to estimates from Retirement Advantage.

‘History tells us that the impact of inflation on consumers tends to be lagged, i.e. companies will try to absorb some of the pain before passing on price hikes to consumers,’ says Thomas Wells, manager of the Smith & Williamson Global Inflation-Linked Bond Fund.

‘Moreover, the broad CPI readings may bear no resemblance to the more severe level of real income erosion that is suffered by some individuals, particularly those living on fixed incomes. Wage growth in the UK remains poor despite the fact that the labour market ostensibly looks strong.’

Incomes are only estimated to have increased by 2.2 per cent year on year in the three months to July, which means that wages are shrinking in real terms.

He adds: ‘At the margin, the hurricanes in the US also pose some modest short-term global inflation risks if energy and gasoline supplies are disrupted.’

However, Ben Brettell, senior economist at Hargreaves Lansdown, says it’s likely that inflation will fall back in the coming months, as the effect of Brexit-induced sterling weakness falls out of the year-on-year calculation.

Beyond the currency effect, he adds that underlying pressures working against inflation include wage growth that remains below long-term averages and sluggish productivity growth. In addition, technological and demographic changes continue to be deflationary forces. Technological change can suppress wages, with the likes of Uber, Amazon and Netflix disrupting traditional industries.

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In terms of demographic change, the generation of baby boomers is retiring and they have already gone through their consumption phase, while younger generations are likely to consume less because their burdened with debt and struggling to get on the housing ladder. 

So, if there is less money to spend and less economic activity, prices are unlikely to be driven upward indefinitely. ‘All in all, I see more deflationary forces than inflationary in the world economy at present,’ says Brettell.

Andrew Tully, pensions technical director at Retirement Advantage, comments: ‘Inflation can have a disproportionate effect on people relying on pension income to pay the bills. Although we’ve seen a move to drawdown since pension freedoms, many retirees continue to value the certainty that an annuity provides.’

He makes the point that over the last year only around one in ten people have chosen some form of inflation link or escalation when choosing a lifetime income. ‘Inflation can very quickly erode the spending power of a fixed income,’ he comments.

‘People looking to take a flexible approach to their retirement finances might want to consider the new retirement accounts. These products combine the certainty of an annuity within the flexibility of drawdown and guarantee an income to pay the bills while also leaving money invested.’

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