The squeeze on household budgets will increase financial insecurity
Wages have been on the rise since 2015 and wage growth this year is set to be between 1.5% and 2%. However, just as wage growth has returned, so has inflation. It is forecast to reach between 2% and 3% this year. This means consumers will lose purchasing power as incomes are squeezed.
That is not only bad news for living standards but means households will become less financially secure. As people are forced to spend more of their income on essentials and regular, inflexible costs like household bills, they have less of a financial buffer to respond to unexpected changes in their circumstances. This could be an income shock — a period of illness or unemployment — or an unexpected cost — a broken boiler or sudden price hike in essential bills.
Everyday household costs
Using the Living Costs and Food Survey data, we looked into household’s everyday needs — food, rent and housing costs, utilities, transport, telecommunications, insurance, debt repayments and savings. As well as being essential, these are often regular, paid on a monthly basis and can’t be delayed. For example, loan repayments paid on a contract and utility bills paid on a monthly basis.
The amount households spend on those essentials varies considerably between income groups. Poorer households (with average disposable incomes of £10,088 or less) spend around 55% of their total expenditure on essentials. The wealthiest households (with average disposable incomes of £63,024 or more) spend around a third.
Low income households spend proportionally more on rent, utilities and food. High income households spend more on mortgages and make larger contributions towards pension funds and life assurance policies.
What does that mean for financial security?
The more a household spends on essentials, the less able they are to respond to a change in circumstances whether that it is reduced income, or an unexpected bill. There are some costs that feel less essential and are easier to vary — like pension payments — but other items like food are harder to cut back on.
When we look at data for the last 10 years, essential outgoings have been relatively stable. Since 2007 overall spending on essentials has not changed a great deal. On average households spent 44.6% of their outgoings on essentials in 2007, and 44.7% in 2016.
However, the latest Consumer Price Index figures released this week show that rising prices for essentials are starting to have an impact on household budgets. After 31 consecutive months of falling prices food costs went up by 0.3% compared to the same period last year, and rising fuel costs have seen transport costs increase by 0.8%. More generally inflation over the 12 months to February 2017 was 2.3%, up from 1.8% in January, meaning it is now at its highest point since September 2013.
As the cost of essentials climbs, essential and regular spending will take up a larger proportion of households’ outgoings — particularly in low income households. That will not only damage living standards, as households have less to spend on things like leisure activities. But it will also mean households are increasingly financially insecure. Spending more on essential, and particularly regular outgoings, means people have less of a buffer so struggle to respond to changes such as reduced income or an unexpected bill.
What can be done?
Policy-makers can help households become more financially secure.
First, there are a number of market interventions which would help households spend less of their income on those essentials. In the energy market for instance, two thirds of households are currently on a standard variable tariff and could save hundreds of pounds a year by switching to cheaper tariffs. We welcome action by the CMA to set a price cap on prepayment meters, used by the lowest earning households, and encourage them taking further action to move the most disengaged customers onto cheaper rates.
Second, and just as importantly, with budgets being squeezed, people need to be better equipped to deal with the financial insecurity that creates. When households need to borrow money to respond to sudden income shocks or expenditure surprises they need to be able to access affordable credit. Extending the total cost cap on payday loans to all forms of high-cost credit would protect families from spiralling debt.
More generally, households need more ways to respond to income and expenditure changes. In the coming months we’ll be looking into some of these issues as we explore how income or expenditure shocks affect households and how they cope with sudden changes.
