Biggest inflation shock in over 40 years has turned Britain into a nation of savers

Official data next Wednesday looks set to show inflation returning to close to the two per cent target, drawing a line under a three-year inflation spike that has left British households spending less and saving more, according to new Resolution Foundation research published today (Friday).

With CPI inflation for April set to fall within touching distance of the Bank of England’s two per cent target for the time since July 2021, the report examines the scale of Britain’s inflation shock, and how it has affected living standards, spending behaviour and the public finances.

The UK’s inflation shock – during which CPI peaked at 11.1 per cent in October 2022, the highest in more than four decades – was the biggest among the G7 economies, and third highest among OECD advanced countries, behind only Sweden and Iceland.

Since March 2021, overall prices have risen by 22 per cent, 15 per cent higher than had inflation remained at its two per cent target, with the UK squeezing over a decade’s worth of normal inflation into just three years.

The cost of essentials has risen by far more – with energy up 90 per cent, and food up 31 per cent, over this period. This has put poorer families at the heart of the cost of living crisis as they spend 50 per cent more of their total spending on these items compared to richer households, says the Foundation.

Despite expectations that households would run down savings, or borrow, to cope with higher prices, the Foundation’s analysis shows the cost of living crisis has in fact turned Britain from a nation of spenders to savers, as households have cut their consumption by even more than their incomes have fallen.

Real household disposable income per person has fallen by 1.1 per cent (or £280 a year) since before the pandemic (Q4 2019), but real consumption per person has fallen much further, by 4.7 per cent (or £1,200 a year). In the last three months of 2023, families saved six per cent of their disposable incomes – the highest rate outside of the pandemic in over 30 years. Had they instead saved at 2019 levels, this would have boosted aggregate spending by £54 billion a year.

This surprise savings boost has seen households cut down sharply on the amount they consume during the cost of living crisis, including on energy (which fell by as much as 11 per cent from their Q1 2022 level) and food (down 7 per cent). Spending on luxury items also fell, including household appliances such as fridges and crockery (down 18 per cent).

As the crisis has eased over the past year, the authors note that almost all of the financial windfall from falling energy prices has been spent on households going out, or going abroad, more, while spending on goods has not recovered.

As well as sparking an unlikely savings habit, Britain has also, more unfortunately, bucked a historic trend of inflation shocks shrinking the national debt. During previous periods of high inflation in the 1950s (peak of 11 per cent) and 1970-80s (peak of 23 per cent), Britain was able to inflate away its national debt, which fell by 11 and 7 percentage points respectively.

This time, however, public sector net debt has risen by 6 percentage points – driven by spending on household support (measures introduced in 2022-23 cost £50 billion in that year alone) and the impact of higher inflation on the value of index-linked debt.

While inflation is finally returning to target, the impact of this recent inflation shock will cast a long shadow, say the authors.

James Smith, Research Director at the Resolution Foundation, said:

“Next week headline inflation should finally return to normal levels, marking the end of the UK’s biggest inflation surge in more than four decades. The sheer scale of this near three-year inflation shock has reshaped the economy and public finances, and changed what people do with their money.

“The crisis has made us poorer, with the sharp rise in the cost of essentials hitting lower-income families hardest. It has also turned us from a nation of spenders to a nation of savers, with credit card spending falling by 13 per cent, and families saving around £54 billion a year more than we might have expected.

“While this high inflation phase maybe largely behind us, its legacy will be felt well into the future, with national debt having increased, rather than being inflated away as we have seen in the past.”