Consumers could pay the price of high inflation for years to come

Central banks could end their rate hike cycles amid falling inflation, but it will do little to ease the financial burden on households in the long term, analysts say

A sign shows interest rates at a bank in New York. Personal savings in the US as a share of disposable income have hit the lowest level since the 2008 global financial crisis. EPA
Powered by automated translation

Consumers worldwide will continue to carry the financial burden of inflation and high interest rates throughout 2024 and beyond, despite indications that central banks could move to end their monetary tightening policies at the end of this year, analysts have said.

The long-awaited US Federal Reserve pivot, when it starts cutting rates rather than raising them, is not expected until the second half of 2024, but it will do little to ease the financial stress on consumers in the long term.

On Wednesday, the US Federal Reserve maintained its federal funds rate at between 5.25 per cent and 5.5 per cent, amid easing inflation and a slowing jobs market.

However, Fed chairman Jerome Powell left the door open for another rate increase at the Federal Open Market Committee’s next meeting on October 31 and November 1 – and warned that its inflation target of 2 per cent could be up to three years away.

“We've covered a lot of ground and the full effects of our tightening have yet to be felt,” Mr Powell said on Wednesday.

“The median projection in the SEP [summary of economic projections] for total PCE inflation is 3.3 per cent this year, falls to 2.5 per cent next year and reaches 2 per cent in 2026.

“If the economy evolves as projected, the median [FOMC] participant projects that the appropriate level of the federal funds rate will be 5.6 per cent at the end of this year, 5.1 per cent at the end of 2024, and 3.9 per cent at the end of 2025.”

Interest rate hikes

The Covid-19 pandemic era of near-zero interest rates and fiscal and monetary stimulus came to an end in March last year, when record-high inflation, a supply chain crunch and the war in Ukraine forced the Fed and other central banks around the world to hike interest rates to cool their economies amid a cost-of-living crisis.

Since then, the Fed has raised interest rates 12 times in an effort to rein in inflation. In August, the Consumer Price Index edged up 0.6 per cent to 3.67 per cent.

Meanwhile, the European Central Bank last week raised interest rates in the eurozone to a record 4 per cent but indicated it could be the last rise in the cycle that has seen 10 increases over the past 14 months.

On Thursday, the Bank of England left interest rates unchanged at 5.25 per cent, bringing to an end its cycle of 14 straight increases after a surprise drop in the UK’s inflation print to 6.8 per cent in August.

Since March last year, the central banks of the UAE, Saudi Arabia, Bahrain and Kuwait have also increased their benchmark interest rates in line with the US.

Most GCC central banks follow the Fed's move on key interest rates due to their currency peg to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.

“Higher for longer seems to be the Fed’s mandate and while inflation is coming down, prices are still high and continuing to rise – just not as fast,” says Ted Rossman, senior industry analyst at New York-based personal finance website

“The cumulative effect on consumers is significant: lower inflation doesn’t mean prices will roll back to 2019 levels. They’ll continue to grow, broadly speaking, just at a slower rate."

Higher interest rates mean a range of personal finance products – from loans to credit cards, mortgages and savings – are affected and borrowing becomes more expensive.

The monetary effect of higher interest rates and inflation on household budgets has also highlighted the importance of financial literacy skills, such as budgeting and having an emergency fund, to protect against rising prices, job losses, salary reductions and other financial shocks, experts say.

Here, we look at why households will continue to feel the pinch as inflation eases amid a possible end to the rate hike cycle.

The UAE — price controls to check inflation

On Wednesday, the UAE Central Bank maintained its base rate for the overnight deposit facility at 5.4 per cent after the Fed hit pause on its monetary tightening for the second time this year.

It also maintained the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 bps above the base rate, the regulator said.

Inflation in the UAE – stoked by increasing energy prices, imported inflation and rising employment – was 4.8 per cent in 2022 and is projected at 3.1 per cent and 2.6 per cent in 2023 and 2024, respectively, reflecting lower energy and food prices, according to the Central Bank. That compares with a global inflation rate of 8.7 per cent in 2022.

Global inflation will fall to 6.8 per cent this year and 5.2 per cent in 2024, according to International Monetary Fund estimates. This is still above the preferred 2 per cent target of central banks.

Certain essential items such as cooking oil, eggs, fresh milk, rice, sugar, fresh poultry, bread, flour, cleaning detergent, lentils, chickpeas and beans are subject to price controls imposed by the UAE government.

Supermarkets are also required to seek permission before raising prices as part of its strategy to keep inflation in check.

While the cost of borrowing for mortgages, loans and credit cards has risen in line with the interest rate increases, banks have been slower to pass on the benefits to savers.

However, digital banks and wealth management platforms are now offering savers higher interest rates on their deposits, such as Sarwa, which has unveiled a cash account with a 3 per cent annual interest rate to help customers boost their savings power.

Digital wealth manager StashAway also raised the rate of return on its cash management portfolio to 4 per cent in February. Abu Dhabi-based digital bank Wio last week expanded its service to retail customers and is offering Plus plan customers a promotional interest rate of 6 per cent per year for savings of up to Dh5 million ($1.3 million).

“The profitability of banks depends on the difference between what they charge borrowers and what they pay depositors,” says Vijay Valecha, chief investment officer at Century Financial in Dubai.

“If the Fed decides to forgo a rate hike … it's likely that the upwards momentum in deposit rates will slow down.”

United States credit card balances at record high

Consumers in the US may have breathed a sigh of relief after the Fed decided to pause interest rate increases this week, but the pressure on their personal finances will continue.

While consumer spending has been relatively robust this year, personal savings in the US as a share of disposable income plummeted to 3.5 per cent in July, the lowest level since the 2008 global financial crisis, according to the Bureau of Economic Analysis.

“The savings built up by consumers through Covid are more or less exhausted and, adjusted for inflation, wage growth is slowing. The latest credit card data shows defaults are rising,” says Bill Papadakis, senior macro strategist at Swiss private bank Lombard Odier.

Credit cards typically come with a variable interest rate of more than 20 per cent in the US, which is directly linked with the Fed’s benchmark rates, according to Mr Valecha.

“The duration for which interest rates will remain elevated before the Fed starts cutting rates is a key consideration, as this is what will affect consumers for a prolonged period, notably the borrowing and spending rates,” he says.

Credit card balances and the interest rates they carry are at record highs in the US, while mortgage rates are at their highest point in 23 years and car loan rates are at their highest level in 15 years, Mr Rossman says.

Rates could fall slightly – between a half a point and a full percentage point – by the end of 2024, he says.

“But that’s not all that much, considering rates have increased by five-and-a-quarter points over the past 18 months,” he says.

“The crystal ball is pretty cloudy at this point. Inflation, especially core inflation, has been surprisingly sticky. And a recent rise in gas prices could pose an additional obstacle to disinflation.”

Mr Rossman recommends paying off credit card balances in full every month to avoid the debt increasing because of compounding interest.

However, if consumers are unable to afford to pay the full amount at once, they could apply for a zero per cent balance transfer offer and pay it off that way.

He also says consumers could seek advice from a reputable non-profit credit counselling agency if they are struggling with debt, or could consider a side hustle to boost their income.

“Do what you need to do in order to pay off this debt as quickly and cost-effectively as you can,” Mr Rossman says.

UK high savings deposits

Consumers in the UK have felt the cost-of-living crisis more acutely than many other developed economies thanks to a raft of financial shocks including Brexit, the Covid-19 pandemic, war in Ukraine, political uncertainty and Kwasi Kwarteng’s disastrous mini-budget that caused economic chaos during his brief time as chancellor of the exchequer in 2022.

Last October, inflation in the UK hit a 41-year high of 11.1 per cent, driven by a broad range of price increases, including for fuel, electricity and food, the Office for National Statistics said.

The rate of inflation has eased since its peak last year. On Wednesday, the Office for National Statistics said inflation had dropped to 6.7 per cent in August despite a rise in the cost of petrol.

Still, the UK is heading towards five years of lost economic growth, as low economic growth and stagnant productivity increases the financial vulnerability of households in the bottom half of the income distribution and the incidence of destitution at the poorest end, the UK’s National Institute of Economic and Social Research said in a report in August.

“Unless there is another global shock on the scale of the pandemic, interest rates will remain higher in the short-to-medium term and consumers need to adjust their finances to cope with the resulting hike in borrowing costs, whether they have an outstanding balance on their credit card, a personal loan or a mortgage,” says Alice Haine, personal finance analyst at Bestinvest, a London-based do-it-yourself investment platform and coaching service.

“For consumers already contending with sky-high borrowing costs, disposable incomes are likely to remain severely squeezed in the near term as the double hit of high interest rates and relatively high inflation take their toll.

“Whether household finances will improve in 2024 depends on how well central banks curb rising prices and how soon interest rates start to retreat.”

One silver lining for UK households is that savings rates have jumped along with the benchmark rate as banks jostle for new business. Currently, banks are offering an average of about 5 per cent a year for easy access accounts, while fixed-rate deposits carry an average of about 6 per cent.

Watch: Would you live in a skip to fight the cost of living?

Would you live in a skip to fight the cost of living?

Would you live in a skip to fight the cost of living?

On Thursday, Nationwide Building Society unveiled a new savings account that pays 8 per cent per year – the highest rate available on the market, according to the lender.

“Customers can save up to £200 [$245] per calendar month in the online managed account, which allows up to three withdrawals within the 12 months after the account opening,” Nationwide said in a statement.

Consumers would be wise to shop around for the best deals rather than relying on their lender to deliver a market beating rate, Ms Haine says.

However, major lenders in the UK are facing stiff competition from smaller players, such as challenger banks, willing to offer better savings rates to attract customers as they look to fund their lending activities, she says.

“While higher savings rates – along perhaps with better pension annuity rates – are typically the only piece of good news for consumers in this high interest rate, high inflation environment, they may edge down slightly if expectations for future interest rates start to come down,” Ms Haine says.

“With savings rates potentially at or near the peak, how far they fall from here will depend on the broader economic picture, but one thing is for sure, the decade-long era of rock bottom savings rates is now firmly behind us.”

Savers must focus on real returns and try to make sure that the interest they are earning on their deposits is, if not beating inflation, then as close to doing so as possible, Ms Haine suggests.

“In the UK, the best savings rates are still some way from providing a positive real return by beating inflation – and it remains to be seen whether the inflation rate falls significantly below savings rates.”

Eurozone standard of living falls

Core inflation in the 20-member eurozone edged down to 5.2 per cent in August, from 5.3 per cent in July, according to European Commission data.

However, inflation varies from country to country in the single-currency bloc. In Germany, the eurozone’s biggest economy, inflation slowed to 6.4 per cent in August, but it jumped to 5.7 per cent in France and 2.4 per cent in Spain during the same period.

Inflation in the eurozone hit a 40-year high of 10.7 per cent last October, driven by a 41.9 per cent jump in energy costs, while the bloc fell into recession in the first three months of this year, Eurostat, the EU’s statistics agency said in June.

The rising cost of living is the most pressing concern for 93 per cent of Europeans, according to a European Parliament Eurobarometer survey published in January.

People are understandably worried about the rising cost of living, as more and more families are struggling to make ends meet
Roberta Metsola, European Parliament President

Almost half of the EU population (46 per cent) say that their standard of living has already been reduced due to the Covid-19 pandemic, the consequences of Russia’s war on Ukraine and the cost of living crisis, the survey said.

“People are understandably worried about the rising cost of living, as more and more families are struggling to make ends meet,” European Parliament President Roberta Metsola said at the time.

“Now is the time for us to deliver; to bring our bills under control, push back inflation and to make our economies grow. We must protect the most vulnerable in our societies.”

The cost of food is a major concern for many Europeans, with French supermarket chain Carrefour last week deciding to place shrinkflation signs in the aisles of all its stores around the country.

Shrinkflation is a common tactic used by retailers in which consumers pay more for less; the price of an item may remain the same or even increase but its size has been reduced.

“Obviously, the aim in stigmatising these products is to be able to tell manufacturers to rethink their pricing policy,” Stefen Bompais, director of client communications at Carrefour, told the BBC.

The Carrefour shrinkflation signs carry a warning for consumers that say: “This product has seen its volume/weight fall and the effective price charged by the supplier rise.”

Bankrate's Mr Rossman says: “I can’t envision many retailers needling their suppliers like this, at least in the US.

“Being aware of shrinkflation is a smart thing for consumers to do – I’m just surprised a retailer would be the one to highlight it.”

Updated: September 22, 2023, 7:13 AM