As real earnings are reduced by rising inflation, consumer spending is at risk; lower-income households are likely to fare worse than others.


The ongoing supply chain crisis and the conflict in Russia and Ukraine are major contributors to the current high level of inflation, which is pushing up the cost of food and energy. Inflation in the United Kingdom recently reached double digits for the first time in forty years, and it is predicted that it will reach 15% by 2023. In the same way, inflation in the United States reached a 40-year high in 2022, peaking at 9.1%. Budgets for individual households are being squeezed, consumer confidence is being impacted, and the cost of living is rising.

In the midst of a recovery, consumers battle inflation. Real consumer spending is expected to increase by 12.1% in 2021, placing consumers at the forefront of the post-pandemic recovery.
1 Thus, their capacity and willingness to increase their purchase volumes will have a significant impact on whether this recovery can be sustained over the medium term. Therefore, it’s concerning to see varying moods in two crucial consumer sentiment indicators. Since early 2021, the Conference Board’s Consumer Confidence Index (CCI) has been trending much higher than the University of Michigan’s Index of Consumer Sentiment Index (ICS), as shown in figure 1. The two measures have never sent such drastically different signals, so this is unprecedented.Inflation’s larger impact on the ICS than the CCI. This raises a more significant query: Does high inflation pose a threat to the expansion of real consumer spending? Yes, that is the answer. Increases in real wages and wealth are slowed down or even reversed by rising inflation, which reduces consumers’ purchasing power. It frequently requires households—particularly those with low and moderate incomes—to cut back on discretionary spending. Even worse, an increase in inflation that is greater than anticipated may necessitate tighter monetary policy, which would further reduce consumer spending motivation. Additionally, inflation worsens income inequality by harming low-income households more than other households.

Consumer expectations are distorted by inflation.

The ICS dropped to 59.4 in March, the lowest reading in more than a decade, as concerns about personal finances and economic growth were largely overshadowed by inflation. In the survey, expectations for inflation in a year have gradually increased since last year, reaching 5.4% in March. Given that headline inflation increased to 8.6% in March—the highest level since the early 1980s—that is not surprising. Core personal consumption expenditures (PCE) inflation, which the US Federal Reserve (Fed) closely monitors, was 5.4% in February and has risen above the Fed’s target of 2% since April 2021.Inflation concerns, which are overwhelmingly evident in the ICS data, are less pronounced in the CCI, which places more emphasis on the labour market. That is a major factor in the higher CCI scores compared to ICS scores. Since the devastating shock of the pandemic’s initial US landfall in the first half of 2020, the labour market has been steadily improving. The employment-to-population ratio is approaching prepandemic levels even though unemployment is currently low at 3.6%. It’s important to note that the CCI does have a section on how inflation affects the economy. Contrary to the sub-index of confidence in the current economy, its sub-index of consumer expectations has been trending downward since last year due to worries about future inflation.

Will living expenses continue to rise?

In the upcoming months, it is anticipated that the cost of many necessities will rise even further. The global Consumer Price Index (CPI), which tracks changes in the prices consumers pay for goods and services, is predicted by J.P. Morgan Research to increase once more in the third quarter of 2022 (3Q 2022) and then increase by about 7.5% in the second half of 2022. (2H 2022). As a result of rising raw material prices, this is an increase from the first half of 2022 (1H 2022), when it was about 6.6%.

“Input cost inflation will continue to be a major headwind until at least the first half of 2023, despite the fact that spot prices have plateaued” (1H 2023).

Prices will therefore continue to rise in the second half of 2022 as businesses try to offset some of these expenses, according to Celine Pannuti, Head of Consumer Staples Equity Research at J.P. Morgan. Prices are anticipated to start returning to normal in 2023 as the effects of cost inflation fade.

While spot prices have reached a plateau, input cost inflation will continue to be a major obstacle at least through the first half of 2023. Thus, as corporates look to offset some of these expenses, prices will increase further in the second half of 2022.

What effects will inflation have on consumer spending and confidence?

Consumers are feeling the pinch, and many are changing their purchasing habits as a result. They are spending less overall, spending less on unnecessary items, and switching from expensive products to more affordable ones.1. Consumers Will Purchase Fewer Goods Overall Due to Rising Inflation
In response to the rising cost of living, many consumers are making financial restrictions. Data analytics company Kantar reports that 47% of British consumers have already reduced or plan to reduce their overall spending as a result of inflation. In a similar vein, research by the intelligence firm Morning Consult reveals that 56% of American consumers are generally willing to shop less. Consumers prioritise buying necessities over luxury items and expensive items; while 75% of shoppers said they would put off buying an electronic device, only 36% said they would buy fewer groceries. “Demand has been quite resilient when it comes to basic staples,” said Pannuti.

Even so, volume growth at significant fast-moving consumer goods (FMCG) companies is suffering, and sales of household necessities are declining. According to data from market researcher NielsenIQ, sales volumes at U.K. supermarkets fell by -9.4% for meat, fish, and poultry, -8.1% for household goods, and -6.4% for packaged groceries in July of this year.

Despite this, businesses have reported strong 2Q earnings, which were largely supported by price increases. “Corporates are beginning to experience slowing volume, but when price increases of 10% or more are taken into account, the overall impact on revenue is minimal. Earnings are benefited from cost inflation’s favorable side effects, according to Pannuti. Unilever is one illustration. While the consumer goods conglomerate reported an overall increase in sales of 8.1% for the first half of 2022, this was actually the result of a 9.8% increase in prices rather than a 1.6% increase in volume sales.

European food, personal care, and home products: price vs. volume

In the European food and HPC sectors, a bar chart in the second half of 2022 shows that volume should decrease as prices rise.
Pricing has been the primary driver of topline growth in the European food and HPC (home and personal care) sectors since the third quarter of 2021. (3Q 2021). It’s anticipated that volume sales will decrease in 2022’s third and fourth quarters
2. As a result of higher inflation, shoppers will switch to own-label products.
Due to inflation, strapped consumers are also switching to own- or private-label goods, which are goods sold under a retailer’s name and typically cost less than their branded counterparts. According to management consulting company McKinsey & Company, about 40% of European consumers have tried a private-label brand this year. This brand-switching behaviour is especially noticeable for essentials like household goods (31%), snacks and confections (27%), frozen foods (29%) and dairy and eggs (26%).

As a result, supermarkets all over the world are noticing a rise in consumer interest in private labels. According to Kantar, sales of own-label products are increasing in the U.K., particularly for price-conscious lines like Asda Smart Price and Co-op Honest Value, whose combined sales increased by a staggering 12%. Conversely, over the same time period, sales of well-known brands decreased by 1%. Walmart’s private brand penetration is rising in the United States, with the growth rate in the food categories doubling in the second quarter of 2022 compared to the first.

Over 2020 and 2021, private labels experienced a general decline in market share as big brands benefited from improved supply chains and rising consumer demand for reputable brands. However, as the consumer cost-of-living squeeze gets worse in 2022, this has, to varying degrees, reversed.”

After losing market share for two years, “private labels are now staging a recovery.”

According to J.P. Morgan estimates, private-label shares in Europe have begun to rise above pre-pandemic levels, with notable increases in the food industry, particularly for ice creams, yogurts, and soups. We observe increases in 29 out of 47 important categories, such as hygiene (paper towels and toilet tissue), bottled waters, and baby food, even though they are still generally below pre-COVID levels in the U.S. It is obvious that consumers are looking for less expensive alternatives to daily necessities, and this behavior seems destined to continue during these times of inflation. Private-label shares in the household, personal care, and food industries in Europe

Since February 2021, private-label stock prices have risen generally, with the food industry posting particularly strong gains. Personal care, consumer health, hygiene, household, and food sector U.S. private-label sharesDespite increasing since February 2022, U.S. private-label shares still trade below pre-pandemic levels.

Reduced Inflation, or Not?

Inflation’s effects on the cost of living will vary by region.

Morgan, J.P. According to research, Europe will be the region most affected by the cost of a living squeeze because of how exposed it is to geopolitical unrest and rising inflation. “While Europe has generally fared quite well, the backdrop for the region gets even tougher in 2H 2022,” said Pannuti. “Additional pressures on consumer budgets are expected due to increased energy costs, and when the tailwinds from reopening start to fade.”

As a result, customers in this area might feel the most pressure to switch to less expensive options.

Consumers in the Americas, on the other hand, are probably going to do better. “Up to this point, the U.S. market has proven to be the most durable during the pandemic and the period of rising inflation. With strong pricing and resilient volumes, Latin America has been the most dynamic region, continued Pannuti.

The situation in Southeast Asia is somewhat contradictory, with some markets—like Vietnam—seeing a greater improvement in consumer confidence than others—like Thailand, where government assistance programs are reducing. According to Pannuti, growth in Southeast Asia has generally increased after two years of decreased activity.

In emerging markets, which are still recovering from the COVID-caused slowdown, consumer confidence is generally higher. “Inflation is a daily occurrence for consumers in many of these markets. They are accustomed to managing the consequences of inflation, according to Pannuti.

Overall, despite these disparate effects, inflation is still a serious problem everywhere in the world. In the months to come, it will continue to have an effect on the cost of living, influencing consumer confidence and spending patterns.

Along with high inflation, consumers must deal with growing inequality.
Rising inflation threatens actual consumer spending and, as a result, economic growth, but it also raises concerns about how it might affect income inequality.

Compared to households with higher incomes, those with lower incomes spend more on necessities like groceries, energy, and housing. According to estimates cited by Fed officials, lower-income households spend about 77% of their budgets on necessities, compared to higher-income households, who spend just 31%. 7 Since food inflation is at 8.8%, the highest level since the stagflation years, and energy inflation is at 32% in March, poorer families are likely to experience the pinch of rising food and energy prices more.It will probably be more difficult for low-income households to switch to other products whose prices are rising. Due to their tight budgets, these households may already be buying inexpensive versions of certain products; therefore, when prices rise, they may not be able to purchase a cheaper version, forcing them to pay more for the product or forgo it altogether. 8
Additionally, research shows that households with low incomes typically rely more on wages and government assistance than households with higher incomes, who also reap the rewards of their investments.
9 Figure 4 shows that while inflation reduces real wages, investment income is typically less affected. 10 High inflation also occurs at a time when pandemic-related transfers have decreased for low-income households.

Optimism may have to wait a little while.

Inflation frequently forces consumers to play a waiting-and-watching game as they adjust to rising prices and wait to see how the economy will be affected in the short term by the counter-inflationary policy. That wait might end up being a little bit longer this year. The Ukraine conflict gave already rising oil prices a new boost in 2021. It will now be even harder for producers who are already having trouble keeping up with rising input costs from passing some of those costs on to consumers. Additionally, COVID-19-related lockdowns and mobility restrictions like those that recently occurred in China’s Shenzhen and Shanghai may cause further disruptions in global supply chains. Unfortunately, the cessation of hostilities and the reduction of backlogs in businesses take time. US consumers will continue to feel the effects of inflation up until that point.