First, the bad news. UK consumer price inflation has already hit 5.1pc in the 12 months to November. And it is likely to rise further in the coming months as businesses pass on more of the price pressure that is already in the pipeline.
In particular, the energy regulator Ofgem is reviewing its cap on domestic gas and electricity bills. The surge in global energy prices means that this cap could be increased by as much as 50pc in April, taking headline inflation as high as 7pc.
With underlying pay growth probably averaging about 4pc, this implies that real wages (after allowing for inflation) could be squeezed by as much as 3pc.
April is shaping up to be the “cruellest month” for other reasons too. This is the month when the planned increase of 1.25 percentage points in National Insurance Contributions (NICs) kicks in, as well as other changes including the freeze on personal allowances and increases in council tax.
It is therefore understandable that commentators such as Torsten Bell, chief executive of the Resolution Foundation, have warned of an “overnight cost of living catastrophe”. The Resolution Foundation has estimated that the average family could face a combined hit of £1,200 in April.
That said, some of this rhetoric is a little over the top. This hit would be spread over the course of the year, so families would not have to find this extra money “overnight”.
“Catastrophe” seems too strong a word as well. Real wages are likely to be rising again by the end of the year, as inflation falls back, meaning the squeeze on spending power should be short-lived. There are already signs that global supply disruptions – at least outside energy – are beginning to ease.
In the meantime, many households did see decent gains in real wages in 2021. There is a danger of focusing too much on one snapshot in time and not taking a longer view.
Many families will also be able to dip into pandemic savings to maintain their living standards, even if their real wages do fall. Fading fears over Covid and increasing job security should give them the confidence to do so too.
Talk of an economy-wide cost of living crisis is therefore exaggerated. It is normal for real wages to ebb and flow over the cycle, and the Government should not try to smooth out every fluctuation.
Nonetheless, even I would agree that the Government will have to act to prevent the worst fears from coming true. Averages conceal a wide range of different circumstances, and poorer households may be especially vulnerable.
In particular, they typically spend a relatively large amount of their income on energy, and are least likely to have a cushion of savings to tide them over.
To be fair, the Government has already taken some action here. The temporary uplift of £20 to Universal Credit has been withdrawn, but changes to the “taper” mean that people will be able to keep more of their wages as they earn more.
April will also bring a relatively large increase in the National Minimum Wage, protecting the real wages of many workers on the lowest incomes. The energy price cap, for all its flaws, has at least shielded households from the worst of the surge in costs over the last few months.
There is still more that could be done. One approach would be to limit the rise in energy prices, but there is no costless way to do this.
The average duel-fuel bill is capped at £1,277, of which the biggest element (£528) is the wholesale price of gas and electricity. Energy companies are already operating at a loss and will have to be compensated by the taxpayer if they cannot increase prices to reflect the rise in wholesale costs since the cap was last set.
There are also some elements directly controlled by the Government, including VAT (£61) and various environmental taxes and levies (£159). These could be cut, at least temporarily, though the money to do so would still have to come from somewhere.
In any event, it would not make sense to shield everyone from the full impact of higher energy costs. Markets and price signals still need to be allowed to do their job of balancing supply and demand. This suggests that the main emphasis should be on protecting the most vulnerable, rather than limiting the rises for all regardless of ability to pay.
This is the job for the tax and benefit system. I have two suggestions here. First, reinstate the temporary uplift to Universal Credit, but at £10 a week rather than £20. This should offset the increase in energy bills for the poorest households, while still encouraging them to economise on fuel if they can.
Second, delay the increase in National Insurance contributions for a year. This will help the poorest families much less than the temporary uplift to Universal Credit, but will benefit middle-income households.
I would delay the National Insurance increase anyway. Even if such contributions were the best way to finance long-term reforms to social care (and few think it is), the money will initially be used to tackle the backlog in NHS work due to the pandemic.
This is a one-off cost that could reasonably be added to long-term borrowing, rather than paid for from current taxation.
Indeed, a sound principle for chancellors, like doctors, is “first do no harm”. The tax increases planned for April are both unnecessary and counter-productive; it still makes sense to borrow more when the economy is weak, and tightening fiscal policy prematurely will simply hold back the recovery.
The Chancellor should hit the pause button now and let stronger growth repair the public finances, as well as ease the burden of the cost of living for the most vulnerable.
This piece was first published in the Daily Telegraph on 31st December 2021