Tony Dolphin of the Institute for Public Policy Research (IPPR) explains the effect the new inflation statistics will have on the UK economy.
The Office for National Statistics (ONS) reports today that consumer price inflation in the UK was 5.2% in September, up from 4.5% in August. Increases in gas and electricity prices were largely to blame but – although these were well known about – the jump in inflation was bigger than anticipated.
The September inflation number matters more than most because it is used to uprate social security benefits from April next year, and also the state pension when inflation is above 2.5% and the rate of increase in average earnings (which it is).
Back in March, the Office for Budget Responsibility (OBR) thought that inflation would be 4.3% in September, so the outturn was 0.9 percentage points above their forecast. As a result, government spending on pensions and other benefits will be £1.2 billion higher in 2012/13 than the OBR thought.
Recent developments make it likely that unemployment will also be higher than forecast by the OBR and this too will add to the projected social security bill.
Their projections were based on the claimant count measure of unemployment averaging 1.51 million in 2012/13. The latest figure, for September, was 1.60 million and most forecasters expect it to increase further in the next few months. It would take an extraordinary turnaround in the economy to generate the growth needed to get unemployment down to the level forecast by the OBR.
It is not all bad news for the government. Higher price inflation will also boost some tax receipts. VAT revenues, for example, will be higher than previously forecast.
But higher price inflation – when it is not matched by higher wage inflation – also has a more general effect. It squeezes households’ disposable incomes and reduces their ability to spend. Higher inflation has been one of the main reasons why retail sales have been flat over the last year.
This in turn helps explain why the economy has not grown in the last nine months and why forecasters now think the economy will expand by less than 1% in 2011 (compared to the 1.7% the OBR was forecasting in March). This downgrade to growth will also necessitate an upward revision to forecast budget deficits.
The chancellor’s self-imposed deficit targets have just become that little bit harder to achieve.
• Economic update – October 2011 – Tony Dolphin, October 7th 2011
• One-Club Osborne drives economy further into the rough – William Bain MP, October 6th 2011
• Osborne: Speaking truth to wealth and power? Really? – Ann Pettifor. October 5th 2011
• UK growth down as IMF warn deficit reduction should not be at the expense of growth – Shamik Das, October 5th 2011
• Gideon’s grotesque attempt to blame workers’ rights for unemployment – Richard Exell, October 3rd 2011
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