Is the cost of living crisis over?
If you’re looking purely at the annual inflation data, the numbers us journalists, not to mention politicians and economists, tend to focus on, the answer might seem like: probably, yes.
Sure, the rate is, at 3.4% in May, higher than the Bank of England’s 2% target. But it’s far below the double-digit peaks experienced in 2022. Plus, the Bank itself thinks prices are likely to drop back down towards 2% in the coming year or two, even assuming a few more interest rate cuts. End of story, right?
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Well, not quite. Because look a bit deeper into the numbers and you notice a couple of important things.
The first is that whether the cost of living squeeze is over really depends on how you slice up the numbers.
Look in a slightly different way and actually this is still an ongoing crisis for millions of families around the country.
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An ongoing crisis
To see what I mean, recall that when economists talk about inflation, they are really referring to something quite specific. The rate at which the average level of prices across the economy (actually, it’s a shopping basket of representative goods) has changed over the past year.
And the change in that level over the past year is indeed 3.4%. But look back a bit further, say the past four years, and the rate of change is 25%.
Why looking back makes sense
Both of these numbers are accurate. They are both expressions of inflation, except that one is for a single year and the other is for a four-year period. But when you’re going to the supermarket, or buying a big ticket item like a computer or a car, are you really thinking back over a 12-month horizon or, perhaps, thinking back further?
For a lot of people, that four-year horizon feels much more representative of their everyday lives and retail decisions than the one-year horizon. True: the fact that it’s up 25% is largely because of the enormous rise in prices in 2022 amid the energy price shock and Russia’s invasion of Ukraine.
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But (and one can’t emphasise this enough), it’s not like prices went up and then went down. The prices went up and stayed up (in fact, they carried on getting more expensive).
And when you look at the four-year, “recent memory” rate of inflation, it’s higher in recent months than any period going back to the early 1990s.
Now, economists have very good reasons for focusing on the annual rate of inflation. But by the same token, you can see why so many people scoff when they see the latest inflation data, finding it bears little resemblance to their lived experience. The problem isn’t so much the data itself but the way we focus on an annual rate.
Expect yo-yoing in the coming months
However, even that annual rate might be in for more of a roller coaster than most economists assume. Because the second important underlying issue to remember is that we’re living through big, consequential geopolitical shifts that could well be very inflationary but are really hard to model.
Consider the events in the Middle East. Military conflict between Israel and Iran has already pushed the oil price up by 18% in June alone. If that price stays elevated, that will feed into higher petrol and other prices in the UK and further afield. And since no one has a clue what will happen next, you can expect that price to yo-yo around quite violently in the coming months.
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More broadly, it’s very hard to know for sure what the impact of tariffs will be on UK inflation. The Bank of England’s estimates in its latest set of forecasts suggested a reassuringly small impact on both economic growth and inflation. But no one really knows whether manufacturers will lift prices just for American consumers or for the rest of the world too.
Finally, it’s worth noting that in much the same way as the past few decades of globalisation were, all else equal, quite deflationary – with prices dropping as manufacturers shifted production to cheaper parts of the world, primarily Asia – the reversal of those forces could be very inflationary.
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Again, all this stuff is very hard to model and forecast. But we are living through a period of volatility, with significant historical shifts. It would be remarkable if that weren’t reflected in the economic data, at some point.
