Open any newspaper or turn on the TV, and before long you’ll come across stories about the cost of living crisis. If you’re worried how the economic situation will affect your lifestyle or investments you aren’t alone, but how much do you actually know about it?
This short guide will give you a crystal-clear understanding of the cost of living crisis. Read on to learn how the crisis began, what’s likely to happen next and what this means for your money.
The cost of living crisis, defined
The phrase “cost of living crisis” refers to the fall in real disposable incomes currently affecting the UK. This means the reduction of the money people have available to spend or save, after taxes and benefits and adjusted for inflation.
Commentators generally agree that the crisis started in late 2021.
The global events that led to the cost of living crisis
It’s perhaps an understatement to say there have been some significant global events in recent times. Here’s how incidents from the past few years have led to the UK’s economic crisis.
The pandemic had a negative effect on many people’s physical and mental wellbeing, as well as causing significant disruption to the economy. Lockdowns put consumer spending on hold, which had one main knock-on effect for businesses.
With revenues tumbling, many companies paused investments and laid off employees. When lockdowns were lifted, the public rushed to spend the money they’d saved, and ongoing supply chain issues meant supply could not keep with demand, driving up prices.
- Supply chain issues
Another hangover from Covid-19 is the break in the global supply chain. The surge in consumer demand caused shortages of materials and packaging on a scale which businesses hadn’t predicted, and that wasn’t the only problem.
Staff layoffs led to delivery delays, as smaller workforces struggled to clear the backlog. When things finally did get moving, new import and export rules meant companies faced further holdups at the border.
- Russia-Ukraine war
In early 2022, just as the global supply chain was righting itself, the war in Ukraine began, creating a raft of new issues. One immediate effect was the fact that many businesses ceased operations in the region, following widespread condemnation of Russia’s invasion.
Prices have skyrocketed because of the conflict, too. Russia is a major supplier of European gas, while Ukraine exports much of the continent’s grain and sunflower oil. So, the war has caused shortages and rising costs, particularly for food and fuel.
4 economic factors that caused the cost of living crisis
The problems faced across Europe and the world have led to changes in a wide range of areas. But which factors have contributed to the UK’s economic crisis?
Put simply, inflation is an increase in the price of goods and services in an economy. A higher inflation rate means people’s money doesn’t stretch as far as it did before.
Excess consumer demand after Covid-19 (demand-pull inflation) and rising supplier costs because of shortages (cost-push inflation) have contributed to a UK inflation rate of 9.4%. That’s the highest it’s been in 40 years, and it could even creep up towards 13% later this year, according to the Bank of England.
The increase in the energy price cap thanks to the soaring wholesale prices of fuel has also squeezed household budgets. With further hikes likely in the autumn and in spring 2023, this situation is set to worsen for millions of households.
- Wage increases
In theory, a higher inflation rate isn’t a huge problem if wages grow at a faster rate. Sadly, that hasn’t been the case in the UK.
The Bank of England forecasts wage growth of 4.75% in 2022. Given the inflation rate is currently almost double that, it’s no surprise that people’s disposable income is shrinking.
- Tax changes
In his March 2021 Budget, former chancellor Rishi Sunak announced the Income Tax Personal Allowance and higher-rate threshold will be frozen until 2026. This amounts to a tax rise, because many more people will be dragged into higher rates of tax when their incomes increase faster than the thresholds.
Sunak did later say, though, that the basic rate of Income Tax will be reduced from 20% to 19% in April 2024.
In addition, the introduction of a new 1.25% “Health and Social Care Levy”, initially as a hike in National Insurance contributions (NICs), came into force in April 2022.
This also reduced the disposable income of millions of people – even though the threshold at which NICs become payable subsequently rose in July 2022.
In economic terms, “productivity” is how effectively an organisation turns its resources into useful outputs.
Better equipment and software for workers can help, but productivity is also driven by a solid national infrastructure: training programmes, provisions for startups, and stable government policies. Unfortunately, right now the UK’s infrastructure just isn’t as solid as it could be.
Productivity gives a country’s economy an extra growth output without the need for additional labour, material, or investment, providing a bulwark against rising inflation. The UK’s low productivity rate means we don’t have that luxury, prolonging our cost of living crisis even further.
What’s going to happen next
Many different events and factors have caused the UK’s cost of living crisis, but inflation remains the main driver. The Bank of England predict the UK inflation rate will continue to rise and won’t fall back to 2% until the end of 2024.
The government are taking steps to stop the crisis, putting measures in place to help the hardest hit. Former chancellor Rishi Sunak has announced £9 billion worth of support, including Council Tax discounts and a grant to help with energy bills.
Get in touch
The media reports about the cost of living crisis are enough to make anyone feel concerned, and rightly so. Now, though, you’ve got a better understanding of what’s happened and what’s to come, and there’s one key point to remember.
As with anything else, the cost of living crisis won’t last forever, and brighter days will likely follow. Use it as an opportunity to take a long, hard look at your finances and investments, and set yourself up for the best possible chance of future success.
If you’re worried about how the cost of living crisis might affect your money or investments, we can put your mind at ease. To find out how we can help you, please get in touch. Email firstname.lastname@example.org or call us on 01189 876655.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.