The Cost of Living Crisis, Part Two?

Mark Twain said that whilst history doesn’t repeat itself, it does often rhyme. This may ring increasingly true in the months ahead, as we move into what you might call the cost of living crisis part two. For most of the last parliament, prices were rising faster than wages and the phrase ‘the cost of living crisis’ became extremely well used. However, inflation then eased, wage rises were evident, and consumers actually enjoyed something of a sweet spot. Today, that phenomenon is set to come to an abrupt end, and something of a sequel to the un-consumer-friendly conditions of a few years ago appears to be in train.

It was in February 2011 that then Labour party leader Ed Miliband first warned of a “cost of living crisis” that would leave middle earners struggling, even when the economy recovers. “My fear for those on middle and low incomes is that more and more families will face a cost of living crisis that will see them left behind, even as the economy eventually recovers”, he said. And, so it proved.

This resulted from a combination of a marked depreciation in Sterling, linked to the Bank of England’s monetary policy (including Quantitative Easing), a lack of pay rises in the UK in the wake of the financial crisis, and upward pressures on global commodity prices.

In Northern Ireland, the period from 2009–2014 was therefore something of a consumer blackspot. Consumer price inflation peaked at 5.2 percent year-on-year in September 2011 and averaged 4.5 percent for 2011 as a whole. The same year food, energy, and motor fuel prices increased by 5 percent, 10 percent and 15 percent respectively. In April 2012, a litre of petrol and diesel peaked at £1.42 and £1.48. Meanwhile you received little change out of £700 for 1,000 litres of domestic heating oil.

Consumer prices increased by over 16 percent during this five-year period, more than three times the rise in average earnings. The period marked five consecutive years of falling real earnings (i.e. after adjusting for inflation). Overall, the average Northern Ireland workers’ pay packet had fallen by 10 percent in real terms between April 2009 and April 2014.

Those on lower incomes were hit hardest, in that a higher proportion of their disposable income is spent on necessities such as food, fuel and transport costs. Therefore their personal inflation rates would be even higher than the headline rate. For example, motor fuel and energy bills increased by 36 percent and 30 percent respectively over this period.  Meanwhile food increased by 17 percent.

This hostile consumer environment squeezed disposable incomes and hit discretionary consumer spending, ranging from new car sales to retail and the hospitality trade.

It was in the build-up to the 2015 UK General Election that the all-encompassing cost of living crisis narrative dropped off the radar. The conditions that contributed to the squeeze changed. Global commodity prices (most notably food & fuel) fell, Sterling strengthened, UK consumer price inflation slumped and wage growth overtook consumer price inflation. All of these factors combined to create what has been dubbed the consumer sweet spot.

Northern Ireland workers saw average earnings for all employees and full-time employees rise by 7.5 percent and 6.4 percent respectively between April 2014 and April 2016. During this period, consumer price inflation was broadly flat (+0.1 percent) which means that inflation adjusted earnings increased by 7.4 percent and 6.3 percent.  These equated to before tax wage increases of £1,543 (full-time employee) and £1,442 (all employees).

 Interestingly, those earners on lower wages have experienced a stronger earnings recovery than their higher wage counterparts. Some might suggest this is a kind-of ‘trickle-up economics’. When adjusted for inflation, the earnings of the bottom 25 percent of all wage earners are some 1 percent higher than they were in 2009.  The bottom 10 percent of earners have almost recovered all of their lost earning power with inflation adjusted earnings in 2016 just 1 percent below 2009 levels. This is the bracket of earners who spend the largest proportion of their income on necessities such as food and fuel.

This rebound in wage growth occurred alongside falling consumer good prices. In 2014 food prices, energy bills and petrol prices all started to fall simultaneously. Indeed 2015 marked the first year that the price of all three of these categories of consumer goods fell year-on-year at the same time. Petrol prices briefly dipped below the £1 per litre mark at the turn of the year although have been on the rise since.

Indeed, remarkably, over the two-years to April 2016 food prices fell -6 percent, energy bills fell by 7 percent, and motor fuel costs fell by almost one-fifth (-19%). The dramatically changed consumer environment was perhaps most evident on our high street with a notable resurgence in the number of new cafes and restaurants.

Looking ahead, however, we are set for consumer price rises – particularly food, fuel and energy – rather than the price falls that we have become accustomed to. For example, petrol and diesel prices are up around 16-17 percent since the start of the year.

The recent plunge in sterling has provided a shot in the arm for exporters’ price competitiveness.  But it is worth remembering that the UK imports more goods than it exports. Manufacturers input costs rose by over 7 percent year-on-year last month with the price of imported materials up 9 percent. Double-digit price rises are evident in crude oil (+14 percent) and metals imports (+19 percent). The latter marks a five-year high. Meanwhile factory gate inflation accelerated to a three-year high last month of 1.2 percent y/y. Whilst still quite modest, the cost pressures already in the pipeline suggest more to come.

In addition to pressure on business profit margins, this will squeeze household disposable incomes and therefore consumer spending. Given that consumer spending accounts for around two-thirds of economic activity, economic growth will be adversely affected too. Two years ago, Northern Ireland became all too aware of the so called “cost of living crisis”.  We look set to become reacquainted with this phrase next year.

The cost of living crisis part two will definitely represent a shock to the household budgets of many – and no doubt to many consumer-facing businesses. However, the global economic backdrop is one of relatively low commodity prices, which means that inflation is coming off a relatively low base, unlike in 2011-14. So, as Twain’s quote suggests, the cost of living crisis part two will go down in history as similar but not identical to its predecessor – the sequel will be significant but should be slightly less hard-hitting.

This is an article that appeared in The Irish News business supplement, Business Insight on 1st November, 2016

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