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Why rising inflation is leaving households feeling the pinch

The economy is growing modestly but consistently and yet many people in the UK, outside London in particular, aren't feeling the benefits.

Rising prices are the reason why.

Inflation in October remained stuck at 3% - the highest level in five years. Pay growth, at 2.1%, isn't keeping pace and the result is an inevitable squeeze on living standards.

Much of the higher inflation we have experienced over the last eighteen months has been imported - that is to say it has been caused by the slump in the value of the pound that followed the vote to leave the EU in June last year.

Sterling has devalued, making the stuff we buy in from abroad more expensive.

The good news is there is some evidence that inflation is peaking, and indeed the headline rate is expected to fall in the months to come.

However, the bad news is some economists believe the pressure on living standards will persist.

  • Why is inflation so significant for households' budgets?

Believe it or not, the average pay packet today is lower than it was in 2008, when the financial crisis began.

The Resolution Foundation calculates that will still be the case in five years time because pay growth will continue to be feeble.

It is forecasting that weaker productivity growth will lead to the worst, and most sustained hit to household incomes in 200 years.

Two weeks ago the Bank of England raised interest rates to protect households from inflation.

At the time, it repeated its view that the productive potential of the UK economy is lower than it was in the run up to 2008.

The Bank of England's Mark Carney. Credit: PA

The point about lower future productivity is subtle and leaves most people cold but it matters greatly because economists believe that lower productivity growth means lower pay growth and lower economic growth.

If the Bank of England is right, then not only will pay rises remain historically weak but the Chancellor will find that the tax revenues he is banking on fail to materialise.

Expect to hear a lot about productivity over the next few week, not least from the Chancellor who delivers his Budget next Wednesday.

The OBR has already said it intends to downgrade its forecasts for productivity. That is likely to have a pretty unpleasant impact on the public finances.