Soaring inflation deals £1,000 blow to household finances

Gas hob

Rocketing prices will deal a £1,000 blow to household finances next year as higher inflation also slashes an expected Budget windfall for the Chancellor.

The surge in inflation will hit real incomes by 2pc by the end of 2022 compared to previous official forecasts, the Resolution Foundation revealed, as Rishi Sunak battles a cost of living crunch.

The think tank said the £1,000 squeeze on households’ budgets, which are relative to the Office for Budget Responsibility’s (OBR) March forecast, will add to “major headwinds to families’ spending power in the coming months”.

The OBR will release its latest official economic and fiscal forecasts at the Budget next week.

Households are already facing a hit from Boris Johnson’s national insurance raid to fund health and social care and a significant rise in energy costs following the spike in gas prices. Inflation is expected to rise above 4pc by the end of the year and remain high well into 2022.

The Resolution Foundation warned that higher inflation will also weaken the Chancellor’s hand at the Budget next week despite a faster recovery.

Its economists predicted that Government borrowing will be £20bn to £30bn lower than the OBR expected this year as the watchdog delivers the biggest growth upgrades in 40 years alongside Mr Sunak’s statement.

However, the think tank said the Budget windfall will be smaller than hoped as a record increase in the OBR’s inflation forecast will increase borrowing costs for the Government. Strong price rises have pushed up gilt yields and the cost of inflation-linked government bonds.

James Smith, research director at the Resolution Foundation, said: “The backdrop to the Budget will be a strong recovery from the pandemic that risks being derailed by rising inflation and economic disruption that will squeeze both the Chancellor’s borrowing windfall and family budgets.

The inflation warning came as traders ramped up their bets on an interest rate rise as early as next month after Bank of England Governor Andrew Bailey sent markets his strongest signal yet.

The divide between economists and investors over raising borrowing costs to rein in inflation widened further with markets now predicting that the Bank’s base rate will rise to 0.5pc by the end of 2021.

Traders have priced in four hikes within the next year to stop inflation running out of control, taking the Bank’s base rate to 1pc - levels last seen in 2009.

Some of the Bank’s former rate-setters are split on the merits of a hike to contain inflation as it would increase borrowing costs for businesses and households, particularly those with variable rate mortgages.

Danny Blanchflower, a former Monetary Policy Committee member, said an early hike would be a “disaster”.

He told BBC Radio 4’s Today programme: “I think they may go and do that but I think it would be a very foolish thing to do.”

Andrew Sentance, another ex-rate-setter, is supportive of higher rates to control inflation but has recommended that the Bank makes its first rate rise in February.

He said: "In my view, interest changes between 0pc and 2pc do not have too much impact on the economy, as long as the changes are well-communicated and are gradual, and people can understand why it is taking place.”

The Chancellor is considering a reduction in the 5pc VAT rate on household energy bills in a bid to ease the pressure building on families, according to the Financial Times.

However, a Government source played down the prospect of a tax cut to help families facing higher energy costs as the crucial COP26 climate summit draws closer.

A Treasury spokesperson said: “We are supporting people with the cost of living, including through a new £500m support fund to help vulnerable households, the energy price cap, and support with energy bills through the winter.

“Our Plan for Jobs is also helping people across the country to find great work and progress in their careers.”