The economic outlook for consumers in 2023

A blog by Consumer Scotland's Director of Analysis, Research and Investigations David Eiser

2022 has been a tumultuous year for consumers. Rapidly rising inflation has eroded disposable incomes, and the government has intervened to mitigate the impact of unprecedented increases in energy prices. But what might 2023 have in store?

Inflation is expected to fall

Have we passed peak inflation? Inflation data released just before Christmas showed the CPI measure of annual inflation at 10.7% in the 12 months to November 2022, down slightly from the 11.1% rate in October.

It may be premature to say that we have passed the peak (inflation will probably remain around a similar rate for the next couple of months), but all expectations are that inflation will fall fairly rapidly during 2023. The Office for Budget Responsibility (OBR) forecasts that inflation will be below 4% by the end of next year.

But whilst the rate of inflation is expected to fall rapidly, prices are likely to continue to increase more rapidly than incomes in 2023. It is only in 2024 that the OBR forecasts that inflation will fall back below 2% and then turn negative (i.e. the price of the typical basket of goods and services consumed will decline slightly).

Falling disposable incomes and rising interest rates are forecast to push the economy into recession

With earnings growth lagging price inflation in 2022 and 2023, this sets the backdrop to a challenging period for household incomes. In its economic forecasts for Scotland published in December, the Scottish Fiscal Commission (SFC) forecast that Scottish households will see an unprecedented fall in their real disposable income of 5.5% over this year and next.

The impact of falling real incomes are exacerbated by rising interest rates. The Bank of England’s decision before Christmas to raise bank rate to 3.5% - with further rises anticipated in the early part of next year – will affect borrowers sooner than any advantage is felt by savers.

Combined with a fall in house prices (the SFC expects Scottish house prices to fall 5% over two years), the SFC believes that the Scottish economy is already in a recession which could last until the end of 2023.

Of course the precise timings and scale of effects are uncertain. But the conclusion that 2023 will see a continuation of falling real disposable incomes seems beyond doubt.

Government support to domestic energy consumers is on course to become less generous from April 2023

Rising gas and energy prices have been a major contributor to the increase in inflation throughout 2022. The Ofgem default price cap provided customers with some reprieve against the immediate impact of rising wholesale prices. Nonetheless, the increases in the Ofgem price cap implied a rise in bills for a typical consumer from £1,277 in October 2021 to £1,971 in April 2022. The price cap would have implied this typical bill rising to £3,549 in October and £4,279 in January 2023 were it not for the Energy Price Guarantee that limits the unit price of gas and electricity.

In response to this outlook, the government’s financial support to domestic customers during 2022/23 has involved a mix of universal and targeted policies.

The Energy Price Guarantee – which caps the unit cost of energy at a level that implies an annualised bill of £2,500 for a typical household until April 2023 – and the £400 Energy Bill Support Scheme are the key elements of the universal schemes (together with quasi-universal payments through council tax). Targeted support includes payments to those in receipt of means-tested benefits, pensioner benefits, and disability payments.

The costs of the support package, which are implicitly borne in large part by future taxpayers, are substantial. The EPG is expected to cost £25bn in 2022/23, whilst cost-of-living support payments are expected to cost £15bn.

From April 2023, the financial support from government to domestic energy consumers is on course to become less generous. The Energy Price Guarantee will increase, capping energy costs at a level which imply a typical bill of £3,000 on an annualised basis. On top of this, the £400 EBSS will no longer apply.

However, the payments to pensioners and those with disabilities will remain at the same cash level as in 2022/23, and payments to those on means-tested benefits will increase slightly. So whilst support becomes less generous for all, it also becomes slightly more progressive across the income distribution.

Latest forecasts suggest that the Default Tariff will be equivalent to around £3,900 in the second quarter of 2023, falling to £3,400 for the second half of the year. The implicit level of government subsidy will therefore fall during 2023, not only because of the rise in EPG, but also because of a reduction in the default tariff.

The cost of the EPG was forecast in November at £13bn in 2023/24, down from the £25bn in 2022/23. The cost in 2023/24 would have been £26bn had the EPG remained at £2,500, as initially proposed under Liz Truss’ premiership.

Energy prices will remain high, and debate will continue about how best to provide support to consumers

Debate is likely to continue throughout 2023 around the most appropriate way to provide support to consumers on energy bills beyond the 2022/23 winter. Whilst wholesale energy prices are expected to fall, they are also expected to remain well above pre-crisis levels. The OBR expects gas prices will peak at £3.70 a therm in the first quarter of 2023, before falling towards £1.90 a therm in 2025; but this is around four times the pre-pandemic price. High energy prices are thus here to stay.

In thinking about how to structure support for energy consumers, several interrelated issues will be debated.

First, whether sufficient financial support is being provided for households with the lowest means, and whether that support is appropriately targeted (with issues including how to support consumers with low income but who do not receive means-tested benefits, and whether support is reaching other vulnerable consumers).

Second, whether the support package takes appropriate account of energy use. A limitation of the flat cash payments to low-income and vulnerable households is that they take no account of energy use, and thus provide relatively more relief to low-income households who use less energy compared to low income households who use more (whose bills increase by more in cash terms).

The Energy Price Guarantee, which caps the unit price of energy, does address this issue to an extent, since it means that heavy users of energy will implicitly receive greater levels of cash support than low energy users. But the limitation of this is that many heavier users of energy are higher income households. So the EPG in itself is implicitly not very progressive.

A wide variety of policy responses to these issues is possible, each with a variety of distributional and behavioural consequences.

Conclusions

2022 has been a year of steeply rising inflation and unprecedented increases in energy prices. Faced with such a large (and partly temporary) spike in energy prices, the government’s intervention to transfer a large proportion of the effects on today’s customers to future taxpayers is clearly justified.

Inflation is likely to fall throughout 2023, but prices are likely to continue to grow more rapidly than earnings. Energy prices are likely to fall but remain very high by the standards of recent history. With the scale of government support set to fall from April 2023, the impact on consumers will increase rather than dissipate.

Debate around how these impacts should be shared across customers with differing needs and means, and between customers and future taxpayers, will continue throughout 2023. Consumer Scotland, the statutory body for consumers in Scotland, will inform these debates and advocate for responses that are fair and that address short and long-term challenges facing consumers.