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Excess Savings Could Fuel Price Rises Despite Government's Plan To Halve Inflation

Inflation remained at 8.7 per cent in May and four times higher than the Bank of England’s target of 2 per cent (Alamy)

6 min read

Savings built up during the pandemic are at risk of being drip fed into the economy and exacerbating price rises despite the Government's pledge to halve inflation, economic experts have warned.

The Bank of England last week raised interest rates by 0.5 points to five per cent as part of efforts to cut inflation, which remained stubbornly high in May and four times higher than the Bank of England’s target of 2 per cent. Core inflation – which excludes energy and food prices – rose from 6.8 per cent to 7.1 per cent. However, UK shop price inflation eased for a second consecutive month in June, as items rose by 8.4 per cent as opposed to 9 per cent in May.

The hike in the Bank's base rate will mean millions of mortgage holders will face higher bills and less disposable income, the aim of which is to take some demand out of the economy by causing people to spend less money, which could curb inflation.

But a number of economic experts are concerned that instead many will use savings built up during the pandemic to plug the shortfall rather than cut their day-to-day costs. Such a case of spending as usual could continue to overheat the UK economy and fuel inflation, undermining Prime Minister Rishi Sunak pledged that he would halve inflation as one of the Government's five priorities for this year. 

Professor Michael Jacobs, an economist and former adviser for former Labour prime minister Gordon Brown, believed households may be using their savings to offset the impact of inflation on incomes. He said it was "notable" that interest rates on savings had not increased "very much" and consumers still "by and large" do not have an incentive to save. 

"In these circumstances, people may feel that they might as well spend their savings since they are getting such a small return on them," he told PoliticsHome

Millions of households have built up cash savings worth thousands of pounds. Data from Oxford Economics found households held “excess savings” that equalled six to 12 per cent of the UK’s GDP.  

Cash savings soared during the pandemic as opportunities to spend money dried up and the UK's furlough scheme replaced millions of workers' incomes. The household saving ratio – the proportion of household resources not spent – hit 23.9 per cent a couple of months after Boris Johnson brought in tough Covid-19 restrictions, according to ONS data. This ratio now sits at 6.8 per cent – 0.8 points higher than the pre-pandemic average. 

Last month Catherine Mann, a Bank of England policy maker, told an event held by investment firm Pictet, that households were continuing to spend their “excess savings”. Mann was concerned this money earned during the pandemic was fuelling inflation, Bloomberg reported.

Jeremy Hunt, the Chancellor of the Exchequer, was critical of banks failing to pass interest rate rises over to savers (Alamy)
Jeremy Hunt (pictured June 21), the Chancellor of the Exchequer, was critical of banks failing to pass interest rate rises over to savers (Alamy)

Jeremy Hunt, the Chancellor of the Exchequer, has been critical of banks failing to pass interest rate rises over to savers. Commercial banks including Barclays, HSBC and NatWest pay between 0.85 per cent and 1.35 per cent compared to the Bank of England's base rate of five per cent, The Times reported. 

Maxwell Marlow, Research Director for economic think thank the Adam Smith Institute, told PoliticsHome if the Government failed to address incentives for saving people would be less inclined to hold on to their money in the face of a higher cost of living. 

“With the Government ever hungry for revenue to fund their lacklustre public service provision, they are maintaining frozen income and savings tax rates which drag more money out of households' nest eggs. This has incentivised increased spending at a time of demand-driven inflation, adding to the economy’s woes,” he told PoliticsHome.

A Government source told PoliticsHome they were concerned that, due to the unpredictable nature of the economy and people’s buying habits, “excess savings” accrued during the pandemic could be spent at any one time and exacerbate inflation.

“When these savings are used, it’ll only increase prices given it'll be when the new money is interacting with goods,” they said.

British households withdrew record amounts of cash last month. The Bank of England said a net £4.6billion was taken out of banks and building societies, according to the FT. Economist Daniel Mahoney at Handelsbanken told the paper there was "strong evidence" consumers were using money they had saved in the pandemic to "sustain living standards".

But not all economists agree that consumer spending fuelled by savings could cause a further inflationary spiral. Tom Clougherty, Research Director at the centre-right think tank Centre for Policy Studies said on a “superficial level” excess savings had added to inflation. But the Bank of England’s failure to raise interest rates quickly enough was the main reason.

Clougherty fundamentally blamed the Bank of England for causing inflation as they kept the “monetary floodgates” open for too long during the pandemic and were “too slow” to tighten monetary policy when inflation became a real threat.

"It's important to remember that monetary policy always works with a lag. It is possible that the Bank has belatedly done what was needed, and that inflation will soon start to come down in response to higher interest rates," he continued. 

Julian Jessop, an economist and senior fellow at the Institute for Economic Affairs, said extra savings accrued since the pandemic was something to be celebrated rather than feared.

“Ideally, we will enter a 'Goldilocks' scenario where the excess savings makes sure the economy is not too cold, and where higher interest rates make sure the economy is not too hot,” he told PoliticsHome.

“There are plenty of reasons to expect inflation to fall sharply, even without further action from the Bank. Interest rates have already risen a long way and the full effects have yet to be felt.

“Growth in money and credit has slowed sharply. Producer price inflation is well down. And some prices are now falling outright, including fuel prices, some basic foods, and domestic energy bills.”

Jessop added that excess savings may not be evenly distributed across all income scales. But he said “the cushion of savings is large enough that it will make a big difference to overall demand”.

Professor Jonathan Portes told PoliticsHome that while savings rose “sharply” in the second half of 2022, there is evidence households are deciding to hold onto them, and that savings driving spending was only "part of the story".

“What is true is that the 'excess savings' were overwhelmingly accumulated by better off households, and it is those households who are doing very well now as wage growth is highest for high earners, while inflation is hitting poorer households harder,” he added. 

The Bank of England declined to comment. 

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