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Inflation battles with saving for the future

We expect the battle between inflation and spending to see a lower rate of growth in overall consumer spending than the optimistic growth forecasts imply.

| 7 min read

Many forecasts, including those from the International Monetary Fund (IMF) and World Bank, assume above-average growth for the main advanced countries this year after a very rapid recovery last. This is brought about by the gradual removal of all remaining restrictions on economic activity imposed to tackle the pandemic.

Many forecasters were expecting the government and central bank policy to remain supportive of growth, though a bit less generous than last year as they start to rein in support. It also assumes that, as things go back to normal, the high savings rate of lockdown collapses and people spend more, drawing down some of their accumulated savings.

Chart 1: IMF real GDP growth forecast

More recently, the IMF reduced its 2022 growth figure from 4.9% to 4.4%, making larger reductions in the growth of the two largest economies. They think the US growth will be 1.2 percentage points lower than their previous estimate at 4%, given the faster withdrawal of stimulus, whilst China growth forecasts were cut by 0.8% of a percentage point to 4.8%, thanks to the attacks on property companies and the continuing impact of virus lockdowns.


As these rises are reflected in energy bills so we will see people having to spend more of their net incomes on simply keeping warm and doing the cooking.

We need to test these assumptions in light of the continuing inflationary pressures apparent on both sides of the Atlantic. US inflation was last reported at a lively 7%, with Euro-area inflation at a high 5%. Within this, energy prices were especially strong, rising 30% over the last year in the US and 26% in Europe. As these rises are reflected in energy bills so we will see people having to spend more of their net incomes on simply keeping warm and doing the cooking. Will this deter from other expenditures?

It is likely to be different depending on income levels. Those on the lowest incomes did not manage to save during the lockdowns and needed government support to help them through. They often lost pay from their lower paid jobs when these were hit by shop and hospitality closures or were unemployed or underemployed already. They will not be able to draw down on savings and will need further government help with their energy bills to avoid a sharp cut to their spending power. Energy is a much larger proportion of their bills.

Governments are looking again at income support, special measures to cut energy bills and price controls. At the other extreme of the income scales, the rich will be able to pay their bills and keep the heating and lighting on as they wish. They are likely to increase their discretionary spending as more travel, leisure and entertainment facilities open-up.

Middle-income bracket key

The economic outcome will be settled by the conduct of those in the middle. They will probably cut their savings rate in order to pay the higher energy bills and may still wish to expand their discretionary spend a bit as well. It is likely those with more savings and a higher income surplus will be more willing to spend, whilst those on lower incomes below the average may rein in discretionary spending a bit as an offset to the large sums going out on energy.

More net income is needed to keep up with the inflation of the basics.

Overall, we expect the battle between inflation and spending to see some lower rate of growth in overall consumer spending than the optimistic growth forecasts imply. More net income is needed to keep up with the inflation of the basics.

In the US, inflation has spread widely. Housing and shelter costs are up 4% on the year, gasoline up 50%, used cars and trucks up 37% and meat eggs and poultry up 12.5%. This squeezes budgets and worries people into a bit more caution. In the Euro area, the 5% inflation is heavily driven by energy costs. Food, alcohol, and tobacco is up 3.2%, considerably less than in the US, and services just 2.4% so far. As central banks raise interest rates, people on variable rate mortgages will feel the squeeze as their payments on the loans go up. Conversely, savers will have some more interest income. The mortgage holders tend to have a higher propensity to spend though there are fewer of them.

Chart 2: Inflation drivers in the US and the Euro zone

The policy response will also have an impact. Where governments are considering fiscal tightening and even imposing some tax rises the propensity to cut discretionary spending a bit will be increased. The USA is still unable to put through the Democrat tax package which is designed primarily to hit those on high incomes, where there will be less spending impact were they to go ahead. Where governments come up with good packages to help those on low incomes with their fuel bills, spending will be better sustained.

The other main variable is what happens to wages. Were employees generally to take advantage of current tight labour markets on both sides of the Atlantic and bid up their wages by at least as much as prices, the spending outlook would in the short term be enhanced. It would also of course then be more likely to bring on a tougher policy response which could well be the dominant influence on stock markets. It currently seems more likely that wage growth overall will stay below the elevated level of price rises now being experienced, intensifying the real income squeeze until we get past peak inflation, maybe around April. We expect some groups of lower paid workers where there are still shortages to gain inflation busting awards, as with drivers and food gatherers.

Chart 3: Unit labour costs (deviation from pre-recession trend)

It currently seems more likely that wage growth overall will stay below the elevated level of price rises now being experienced, intensifying the real income squeeze until we get past peak inflation, maybe around April. We expect some groups of lower-paid workers where there are still shortages to gain inflation busting awards, as with drivers and food gatherers.

The main central banks have all announced a reduction in support and many are talking about rate rises. The aim of this will be to dampen demand and reduce new credit. So far, Japan remains a special case with little inflation and continuing stimulus. The European Central Bank has issued strong guidance that there will be no rate rises this year, but there are pressures for them to make more rapid progress to tighten given the high level of inflation already achieved.

The IMF was right to shade its growth forecasts and they may still be on the high side. Inflation, one way or another, damages output and adversely affects equity valuations.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Inflation battles with saving for the future

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