Why Has the Cost of Living Increased in the UK?

In December 2021, after a year of continuous rises, the cost of living hit its highest recorded level in several decades. This impacted upon the general ability of UK households to afford goods and services. But what is the reason behind such a stark increase in the average cost of living in the UK, and why has it hit household budgets so hard?

Prices in the UK are rising faster than at any other time in the past 30 years, and wages are not keeping up. This has resulted in people’s money not going so far.

What is inflation?

Inflation is the rate at which prices are rising. If the price of a loaf of bread is £1, and it rises by 5p, then bread inflation is 5 per cent. Whilst in normal circumstances, you may not notice subtle price rises from one month to the next, at the moment, prices are increasing at such a rate that average pay is not keeping up.

In the 12 months to January 2022, prices rose by an average of 5.5 per cent. Conversely, regular pay, excluding bonuses, dropped 0.8 per cent. This excludes industries that are in high demand, such as lorry drivers, where wages are increasing faster than prices.

Inflation is measured by the Office for National Statistics (ONS), which records the prices of hundreds of everyday items. These items are called the “basket of goods”, and they’re being constantly updated.

For example, in 2021 hand sanitiser and men’s loungewear bottoms were added because they had become popular during the COVID lockdowns, but sandwiches bought at work were removed due to people working more from home.

The ONS releases its measure of inflation each month, revealing how much prices have risen since the same date last year. This is known as the Consumer Prices Index (CPI).

Consumer prices, as measured by CPI, were 5.4% higher in December 2021 than a year before.

In early February, the Bank of England warned that inflation could rise above 7 per cent this year. Other private forecasters agree with the prediction.

What is driving up the cost of living in the UK?

One of the biggest drivers of inflation is energy prices. Household energy tariffs have seen significant increases in price, and petrol costs have risen considerably. Between January and November 2021, domestic gas prices rose by 28 per cent, and domestic electricity by 19 per cent.

In early February, the energy regulator Ofgem announced that the cap on energy prices would increase from its current equivalent annual level of £1,277 per year to £1,971 per year, representing a 54 per cent increase.

Food and non-alcoholic beverage prices rose by 4.2 per cent in the year to December 2021, and may rise further over the next few months, having a considerable impact upon inflation. Regulated rail fares, and TV and broadband prices, are also set to rise in March 2022.

What’s more, household budgets may be squeezed by changes in taxes and benefits in the coming months. This includes an increase in National Insurance Contributions from April 2022, as well as changes to income tax and the removal of the £20 Universal Credit uplift. Stagnant wages may also impact household incomes, and rising interest rates will increase mortgage repayments for some homeowners.

Can anything be done to tackle inflation and the rising cost of living UK wide?

Traditionally, the Bank of England’s strategy for dealing with rising inflation is to put interest rates up. This they have done twice in the past two months.

Putting interest rates up means that some people who have borrowed money could see their repayments rise, especially those with mortgages linked to the Bank of England base rate. The idea is that when people are paying out more for their borrowing, they will have less to spend on other things. With less demand, prices stop rising so quickly.

However, when inflation is down to external forces, such as the global squeeze on energy prices, then putting up interest rates may not be the right move. Instead, the government may decide to cut taxes on consumer items that are rising quickly. Measures have already been announced to reduce the impact of energy price rises.

Looking for tailored financial advice?

Here at Partridge Muir & Warren, we have an in-house team of tax advisers, financial planners and legal specialists ready to provide you with the advice you need to help you deal with the rising cost of living in the UK.

To learn more about how we can assist you, please get in touch.