Financial pain for households set to increase

Roger Bootle, an economic adviser with Deloitte, says in the firm's latest economic review that real earnings are almost certain to fall by about 1.5 per cent, the fourth successive annual fall, the first time this has happened since the 1870s.

He said a number of factors will maintain pressure on household incomes in the near-term. Growth in pay is unlikely to catch up with inflation any time soon, he said, and inflation is heading towards, and possibly above, 5 per cent.

While pay settlements have began to increase, Bootle casts doubt on whether they will rise much further when unemployment is still high and the public sector faces a pay freeze.

"An additional reason to be pessimistic about the outlook for household incomes is the deepening fiscal squeeze," he said.

"Admittedly, there have recently been some not insignificant tax giveaways, including the rise in the personal income tax allowance. However, the net effect of this year's direct tax changes will still be to reduce household incomes."

Bootle argues that the labour market outlook provides further cause for concern. "I still doubt that the private sector can compensate for the cuts in public sector employment - which is already falling by 100,000 a year. I doubt that firms will want to hire many more people when the health of the recovery is in so much doubt," he said.

"I still think further job cuts in the private sector are possible and expect overall unemployment to keep rising for most of this parliament."

Bootle added: "The upshot is that I expect households' disposable incomes to fall by about 2 per cent this year in real terms - equivalent to about 780 per household.

"And it will take until 2015 or so for incomes to get back to their 2009 peak."

Bootle says real incomes do not provide the definitive picture of the health of households' finances, but taking a broader look at the situation arguably leaves the position looking even worse, he claims.

"In terms of the year-on-year change in circumstances, although not the absolute level, that would make 2011 the worst year for households since 1977 (the depths of the recent recession aside).

"Were interest rates to rise too, conditions would arguably be the worst for households since 1952."

In these circumstances, he argues, consumers may have little choice but to cut their spending. He predicts that spending will drop by 1 per cent this year and by about 0.5 per cent in 2012."Of course, we need to remember that recent and looming falls in real incomes will reverse only a small part of the gains achieved over the past few decades."

However, on a more positive note, he believes more favourable conditions lie further ahead.

"I still think that inflation will fall sharply next year and will be below its target by the end of 2012, allowing real incomes to start rising again.

"And by the end of this Parliament, taxes could be falling rather than rising. But for those households struggling to make ends meet, that may still seem an age away."