Sunday, July 09, 2023
We splashed the cash - and helped push prices up
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Today I want to try to address the puzzle of consumer spending and, along the way, kill several birds with one stone. And, before getting tied up in my own idioms, let me start with an anecdote.

The other day I was trying to book two overnight stays later in the summer. The well-known hotel booking site I used told me that in the first case, 96 per cent on properties were unavailable on the relevant date, and for the second it was 94 per cent.

Those that remained were eyewatering expensive. Even the one which gives you your money back if you don’t have a good night’s sleep was very pricey. Camping has never seemed more attractive, though I have not checked out campsite prices.
What is happening here? Strong demand is running up against limited supply – hospitality is labouring under both rising costs and recruitment problems – pushing up prices. The “accommodation services” component of the consumer prices index is up by 14.4 per cent over the past 12 months alone.

This goes to the heart of the consumer spending puzzle, and why so many people struggle to understand why higher interest rates are necessary to bring down inflation.

Looked at in real terms, in other words adjusted for inflation, consumer spending is very weak, as is the economy in general. The volume of household spending in the first quarter of this year was 2.3 per cent below pre-pandemic levels in the final three months of 2019.

You write the British consumer off at your peril, but this weakness is one reason why gross domestic product, on a quarterly basis, is still below pre-pandemic levels. UK consumers have been harder hit than their American or eurozone counterparts. There are many reasons for this, but one is that this country was harder hit by the energy shock and has suffered a more enduring food price shock. You can fill in your own explanations.

If I give you a different measure of consumer spending, however, one in cash or current prices, a different picture emerges. What economists would call expenditure in nominal terms is more than 14 per cent higher than before the pandemic. Over the latest 12 months, it is up by 9.7 per cent, compared with a rise of just 0.2 per cent in real terms.

You can see a similar picture for retail sales. In the 12 months to May, sales values, excluding petrol and diesel purchases, were up by 7.7 per cent. Sales volumes over the same period were down 1.7 per cent. Retail sales in volume terms are below pre-pandemic levels, while values are up by 16 per cent.

Looking at this, you may say all I am demonstrating is the impact of inflation, which is true. But there is more to it than that. The 9.7 per cent rise in consumer spending in current prices over the latest 12 months shows that there is a lot of money sloshing around. In normal times, if inflation were in low single figures, spending growth on that scale would add up to a very considerable consumer boom.

The growth in spending has, I should say, been unevenly spread, rising most in cash terms for food, up 13 per cent, housing, including bills, up 12.5 per cent but, in contrast, clothing and footwear was up just 1.2 per cent. The retail sales figures are already showing big annual falls in volumes for non-essentials, including furniture, carpets and electrical household goods. See Curry’s latest results.

The growth in cash spending also provides context on “greedflation”, the suggestion that firms are responsible for inflation by increasing margins. There has certainly been less evidence of competitive pressure, and not just in the petrol market. But businesses are just doing what businesses do, pricing according to what the market will bear, which has been quite a lot. When demand subsides, the picture will change.

Where is this money coming from? After all, real wages are falling and the cost-of-living crisis has yet to go away. Wages and salaries did not rise enough over the period to cover the spending growth, increasing by 6.5 per cent, though other sources of income meant gross disposable income per head rose by 8.4 per cent (in real terms, it fell). Households also saved less, borrowed more and, importantly, received a lot of government support.

This leaves us with the situation at present, where growth in cash spending is both driving and being eaten up by inflation. This split between values and volumes is extreme and highly unusual. Past periods of high inflation have been associated with big increases in spending volumes.

Looked at from the perspective of policymakers, and indeed everybody else, you would want desperately to change this. A situation in which consumer spending is rising by 10 per cent in cash terms and not at all in real terms is neither sustainable nor healthy. What you would want to achieve is a situation in which nominal spending is rising at an annual rate of 4 per cent or so, split between 2 per cent inflation and 2 per cent real-terms growth.

Can it be done? Take away the exceptional growth in energy prices, which is now starting to happen, and that gets you part of the way there. There is also tentative evidence that food price inflation has peaked and should be heading lower.
As for the rest, though the effect is slower than in the past, the aim of tighter monetary policy – higher interest rates – is to squeeze out some spending,

encourage people to save more, not less, and force businesses to pare back pay increases. Interestingly, the latest British Chambers of Commerce quarterly survey showed both that a smaller proportion of firms plan to raise prices and that labour costs are now the main source of upward pressure on prices, taking over from energy and raw material costs.

As firms face greater price resistance, they will be under more pressure to resist wage demands. The Bank’s big worry is what are known as “second round” effects, as wages respond to higher prices.

In theory, all the ducks should be in a row. Taxes, as I noted the other day, are also rising, though in the case of income tax and national insurance it is a tax hike by stealth. There should be no need for the 7 per cent official interest rates now being talked about by some in the markets, though we could do with some encouraging figures after a series of inflation disappointments.

It makes sense to bear down on demand, and the amount of money sloshing around. Perhaps in time, it might even make it easier to book a hotel room.