The cost of living crisis – what comes next?

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June 05, 2023

13 mins read

Are we facing another lost decade in living standards? And, if so, what might this mean for interest rates, mortgage repayments and the labour market? Find out in our discussion with Paul Johnson, Director at the Institute for Fiscal Studies.


Sangita Chawla: Hello, I'm Sangita Chawla, Chief marketing officer at Standard Life. Today I'm excited to have on as our guest speaker once again, Paul Johnson. Paul has been the director of the Institute for Fiscal Studies since 2011. He's also a visiting professor in the Department of Economics at the University College London. Today, Paul is going to share his insights on the UK economy and what this might mean for people's long-term savings and retirement plans.

Hi, Paul. And welcome to Thinking Forward.

Paul Johnson: Thank you.

Sangita Chawla: You've recently said that households face another lost decade in their standard of living, with disposable incomes likely to be no higher in 2027 than they were 10 years ago. So what's happening to the UK economy and how are we comparing to other countries?

Paul Johnson: Well, that's not a good decade for any economy. We've over long-time history, we've expected our incomes to rise by one-and-a-half, 2% a year, and that makes a big difference over time. We've already lost, the average earner’s already lost thousands relative to what they might have expected before the financial crisis, because earnings have risen very, very slowly ever since 2008. And the worrying thing is that it looked like they might be beginning to get a bit better in 2015. And then that went down again. And then pre-pandemic, it looked like they might start to get better again and that's stopped.

So we're looking at possibly getting on for 20 years, by the time we get to the middle of this decade, with very little increase in household incomes. And of course, that reflects a very poorly performing economy. We’ve had very slow growth in productivity for a very long time now. And as we’ve come out of the pandemic, we’ve come out of it less well than nearly all of our competitor economies. Whereas we've only just got back now in the first part of 2023 to where we were at the end of 2019, just before the pandemic, all of the other major economies were back there some time ago. So we've got a more difficult economy and a more difficult period for living standards than most of our competitors.

Sangita Chawla: Well, it doesn't sound like it's a surprise to you then. So we're in a worse position than other countries by what you're saying. And of course, the pandemic hit. That didn't help. And more recently, we've got a cost-of-living crisis. I was just reading in the news the continued strain that households are facing. We're all feeling it. You go to the supermarket, you see how prices have gone up. And I was reading that grocery inflation has gone up 17% in in the month just recently. Broadband is rising, mobile phone prices are rising, up 17%, it’s likely to be. So how do you see this cost-of-living crisis developing?

Paul Johnson: Well, it's part of the problem. Part of the reason, of course, that incomes are not rising over a long period of time is that in real terms, prices are rising so fast. And remember, the Bank of England target is to have inflation at 2%, too. So to have inflation at 10% really is pretty disastrous. I mean, this is the highest period of inflation since the late 1970s. I never thought actually we'd see a return to this. And as you say, food prices are rising very fast. Of course, energy prices have risen a lot. I mean, these are necessities. So people really struggle to move away from those kinds of things. And obviously, this hits lower income households hardest in general because they spend a big fraction of their budget on those sorts of goods.

And whilst earnings are rising, they're not rising as fast as prices. So it sounds good. Earnings are rising 6% or 7% a year, but prices are rising 10%. So we're all getting worse off as a result of that. And then layer on top of that for people who've got mortgages with interest rates going up so fast, that's having a really big effect on particularly younger people with mortgages, particularly people with big mortgages, actually on average equivalent to about another 10% on overall price increases. So that's how it feels to people with significant mortgages. It feels like they've had a 10% hit to their disposable income.

Sangita Chawla: It's a tough time for many people. I think, you know, we know at Standard Life, many of our customers are saying the same thing. Encouragingly, though, what we aren't seeing is people stopping pensions contributions despite this and, you know, Standard Life, we're a brand that looks after customers. We're interested in what customers think. We research what people are telling us around behaviours, attitudes. We did a survey back in the autumn to test out attitudes again with the cost of living, and what we found in that survey was that more people were likely to stop their Netflix contribution contributions and monthly payments than they were to stop their pension contributions. Now that's encouraging at one level that people are still thinking about their long-term savings. But is that likely to continue with all this continued pressure, or are we going to see it flip around? Any thoughts on that?

Paul Johnson: Well, quite often when the economy is doing badly people get nervous about the future. And so they prioritise making sure that they've got money available. So we've seen that to some extent overall sort of savings levels in previous downturns. And when things are going well, people feel more happy spending. Of course, you've got the additional impact here of automatic enrolment where a lot of this is just driven by a degree of inertia. Actually, it's quite hard to stop your pension saving nowadays, probably harder than it is to stop your Netflix account. And that's, I think, one of the reasons, one of the big positive effects of the pension system we have at the moment is that it really uses that force of inertia, which is keeping people in. And I think whilst that continues, unless things get a lot worse in terms of the pressure on household budgets, I think most people will probably continue to be putting money into their pensions. They may be reducing other savings, they may actually end up borrowing elsewhere. But I think our experience of auto enrolment has been so positive and the impact of the inertia has been so high that my guess is that that's how it will pan out.

Sangita Chawla: You talked a little bit about the lower income groups suffering a little bit more and feeling the pain more, are you thinking that's just going to continue if we don't sort of get to a point of getting inflation under control and interest rates back down? Is it a tough six months ahead, do you think, for most?

Paul Johnson: I think it will still continue to feel tough for at least the next six months. Inflation will come down. I mean, the big impact of rising energy prices will come out and so eventually will the big impact of rising food prices. So just arithmetically, the headline inflation rate will come down, not I think as far as the Bank of England's target of 2% by the end of the year, but almost certainly the Prime Minister's pledge to halve inflation by the end of the year will be met.

But that in itself isn't going to make people feel better off because, of course, lower inflation just means prices are rising less quickly. It doesn't mean prices are going down and our incomes won't have caught up. And, of course, there's still lots of people on fixed-rate mortgages who are going to come off of those over the next two or three years actually. So there’ll be new groups of people who are really being affected by this as we go through the next couple of years.

Sangita Chawla: As you say, one of the things that the Government's been very focused on, as well as the Institute of Fiscal Studies, and we have too as an employer, is what do we do about the people aged 50-to-64? We saw a lot of people exit out of the labour market during Covid. We've found there's many reasons for this, for many it’s actually just because they wanted to. And we're all sitting here saying, well, actually, can we do something about enticing those group of people back in? We saw with the reforms that came through a month ago, the government is very focused on that area. Are you feeling positive about that? Or what do you need to see to feel positive that traction is being made with that group?

Paul Johnson: Well, you're right. I mean, we've lost probably something like half-a-million people from the workforce among people in their 50s and early 60s relative to where we were pre-pandemic. And interestingly, this is one of the few things that other countries haven't seen. So most other countries have seen inflation and a lot of the things that we're seeing, but they haven't seen this withdrawal from the labour force and exactly why we're so different – actually, I don't think we really know.

Several things seem to be going on here. There's clearly a big increase in the number of people in that age group who are reporting themselves as being sick or disabled, really big increases. But that doesn't immediately appear to be what's driving this withdrawal from the labour force, because a lot of those people appeared to be not in work before, saying that they were retired or unemployed or something, and now they're saying they're sick. So maybe they've been particularly affected by post-pandemic impacts.

What we are seeing is a lot of people voluntarily retiring earlier than they otherwise would have done. And these are largely people, I mean, almost exclusively people who own their homes outright and often people who have got pensions or partners who are in work. So in other words, they're able to manage at least for a significant while off their own resources. Now, very high levels of inflation may make that more difficult. So they may decide they've made a mistake there. But these are often groups that it's quite difficult for government to get to because they've done the right thing, they've saved, they've got some money and they've made the decision they would rather spend the time in the garden or travelling or whatever – not on the not on the nine-to-five.

Sangita Chawla: So thinking forward next year, and the year after, surely things have got to get better?

Paul Johnson: Well, I hope they will eventually. If you look at the forecast, it looks like last year and this are going to be terrible for household incomes. And if you look at the Office of Budget Responsibility forecast, they reckon these are going to be the worst two years in recorded history, actually. So since about since the 1950s for household incomes. But the sort of the light on the horizon is that it looks like things will start to move in the right direction after that and household incomes will start rising again, the economy will start growing, and we'll at least get back on-track. Unfortunately, it will be a lower track than we were on before. So what appears to happen is you look back at the financial crisis, 2008–2010, things plunged and they never quite recovered. And then you had Covid and things plunged and they never quite recovered. But we will at least start to grow again. And hopefully over the second half of the 2020s, we’ll at least get back to something approaching the normal rates of growth in incomes that we've seen in the past. It's just that it'll be growth from a much lower level than we might reasonably have expected.

Sangita Chawla: And presumably the rest of the world is looking at the UK thinking things are improving, I hope?

Paul Johnson: Well, I think the rest of the world will be looking at us thinking, well, at least they haven't gone quite as crazy as they did last autumn, when it was really quite embarrassing talking to people from pretty much anywhere.

Things have clearly improved since then. Things have stabilised. We're no longer –which frankly, we were back in September – we're no longer an international laughing stock. And I think that the rest of the world will hopefully soon, as I hope we do soon forget, what happened a few months ago and get back to something slightly more normal.

Sangita Chawla: And I think I think many of us are forgetting, aren't we, about what happened, particularly as the markets are starting to recover and we're seeing a bit more positive sentiment. So it sounds like we've got more to look forward to, thank goodness. Well, it'll be great to have you back on the show six months, twelve months down the line to see how we've improved things. But thank you for today. It's been great talking to you and we look forward to talking to you again soon.

Paul Johnson: Thanks very much. I look forward to it, too.

Sangita Chawla: That brings us to the end of the episode. I'd like to say a special thank you to Paul Johnson for joining us for this fascinating discussion on the UK economic challenges and what this might mean for people's long-term savings and retirement plans. If you enjoyed our discussion today, you can find more interviews and podcasts on our website. Just search for Standard Life Thinking Forward. I hope you enjoyed it and look forward to seeing you all again soon. Thank you.

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