When we look back at 2023 in a few years’ time, there will be just one word that will dominate any conversation about the UK economy.

Inflation has been the single most important issue that has affected every aspect of our lives over the last 12 months from the decisions made by politicians at Westminster and the Senedd to heating our homes, feeding our families, and paying our mortgages.

At the beginning of this year, inflation in the UK stood at 9.2%, one of the highest levels in the last 40 years, and whilst it has reduced dramatically since then, its impact has been substantial on various aspects of our economy and society.

One of the most immediate effects of inflation in the UK was the erosion of consumer purchasing power. As prices for essential goods such as food, housing, and energy rose, households found that their income could buy less than before. This situation was particularly hard on lower-income families, who spent a larger proportion of their income on these necessities.

For example, the Living Wage Foundation found that 39% of low paid workers reported regularly skipping meals for financial reasons and falling behind on household bills, with 32% being unable to heat their homes and 27% falling behind on rent or mortgage payments.

In response to rising inflation, the Bank of England increased interest rates to control inflation and at the beginning of 2023, the rate was 3.5% subsequently increasing this to 5.25% in August. The increased borrowing costs have impacted mortgage rates, loans, and credit card interest rates, leading to decreased consumer spending and investment by businesses.

Those that bought their homes during a period of low interest rates had a rude awakening as banks and building societies responded to higher interest rates by not only increasing the cost of repayments for mortgages but also by withdrawing products from the market. Many with low fixed mortgage rates suddenly saw their monthly bills increase dramatically by hundreds of pounds every month as they adjusted to new higher rates. Indeed, it’s estimated that over four million households faced higher mortgage bills in 2023, reducing their spending power.

The cost of production for UK businesses also increased due to inflation. This was especially true for industries heavily reliant on raw materials and energy, both of which experienced price hikes. These increased costs have undoubtedly led to reduced profit margins and decreased business investment which, in turn, have clearly affected a UK economy that has failed to grow.

Another consequence of inflation has been the demand for higher wages, a problem which has been exacerbated by an increase in vacancies in several key industries following the Covid pandemic, giving jobseekers bargaining power for higher wages. For example, the most recent statistics showed that the annual growth in regular earnings was 7.3%, considerably higher than in previous years although that is not to say everyone was satisfied with pay offers. In fact, an estimated 2.5 million days lost to labour from January to October 2023 as trade unions sought to obtain pay settlements for their members that would deal with the consequences of higher inflation.

On a wider fiscal scale, the rise in inflation has directly impacted government finances, especially the cost of servicing government debt which this year rose to above 100% of GDP for first time since 1961. It has also increased the cost of running government services which has led to considerable pressures on the cost of public services in both Westminster and the devolved nations.

Therefore, inflation in 2023 posed a significant challenge to the UK economy, impacting all of us in various ways. Given this, will anything change as we enter the New Year?

With inflation now down to 3.9%, there is an expectation that it will continue to fall and far faster than many economists predict. For many households and businesses, the indicator that could have the biggest impact is that of interest rates although the decision on whether they fall or not is not in the hands of politicians but that of the Bank of England’s Monetary Policy Committee.

Whilst they have previously been criticised for being overly cautious when inflation was rising two years ago, the recent announcement that the UK economy has flatlined and is close to entering recession could be the trigger for a far earlier than expected reduction in interest rates in 2024 with banks already introducing cheaper mortgage products.

This decrease, along with further drops in inflation, could finally begin to ease the cost-of-living crisis that has affected all of us over the last twelve months and hopefully 2024 will be a better year financially for consumers, households, and businesses across the UK.

Blwyddyn Newydd Dda. Happy New Year.