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Business Comment

Russell Lynch: Labour is heading up a dead-end street with its 'cost-of-living crisis'

Economic View: Wages will close the gap on the cost of living and rising house prices will lift the mood

As summer fades, prepare for a blizzard – a blizzard of soundbites during the party conference season. One phrase you'll soon be sick of is: "Cameron's cost of living crisis". Labour leader Ed Miliband wants to fight the next election on the "quiet crisis" hitting household budgets, while David Cameron and George Osborne hand out tax cuts to millionaires. Expect the message to be hammered home endlessly when Labour holds its conference in Brighton.

The cost of living, as measured by the consumer prices index (CPI), stands at 2.8 per cent and is currently rising at more than twice the annual average increase in wages, up 1.1 per cent a year in the three months to June. Obviously it's not great news for families, but to listen to the Opposition, you would think that inflation was exclusively a coalition phenomenon.

The "cost of living crisis" was already under way while Gordon Brown held the keys to Downing Street, as shown by the graph, courtesy of Berenberg Bank. This shows real wages for UK workers – that is, average weekly earnings dividend by the CPI – since 2005, indexed to 100 at the end of 2007. A good chunk of the fall happened under Labour. A delve into the inflation figures also underlines how much is dictated by the vagaries of international commodity markets, which are no respecters of whichever party happens to be in power.

Take three examples, all of acute sensitivity to household budgets. The Office for National Statistics' (ONS) broad category of housing, water and fuels rose 13.6 per cent over the three years before the last election, and 15.8 per cent in the three years since June 2010. Price increases in food and non-alcoholic drinks are virtually identical in both periods, up 16.5 per cent in the period before the last election, and 16.4 per cent in the three years since. An attempt to make political capital out of rising petrol prices presents even bigger problems for Labour. Liquid fuels including petrol rose 23 per cent in the three years to 2010, and 15.6 per cent since – still painful, but a lower rate of increase.

The Bank of England has regularly set out the three main reasons for consistently overshooting its inflation target in the past six years: global commodity prices; the fall in the exchange rate, pushing up the cost of imports; and VAT rising to 20 per cent in January 2011. Of these, the Government could be held directly responsible for VAT, although we know that Labour considered plans of its own for a rise to 18.5 per cent if it had won the last election.

Other pressures on the CPI include the big rise in university tuition fees to £9,000 from last year, adding 0.4 percentage points to the annual inflation rate. But again the shameful conspiracy of silence between the two main political parties over university fees – safely parked in Lord Browne's review for the duration of the election – suggests Labour would have acted little differently.

Aside from these points, the bigger picture is that falling real wages in a more flexible labour market were a far better option for millions of families than the alternative of much higher unemployment, whoever was in power.

There are other problems with Labour's "cost of living crisis" narrative for 2015. Mr Miliband was right to highlight the longer-term trends in inequality of wage growth as the salaries of the top 10 per cent have risen nearly twice as fast as those of middle earners in recent decades. But the Government can also answer the Opposition's attacks with evidence of falling income inequality between 2010-11 and 2011-12. A little-remarked study by the ONS a month ago showed average incomes falling by £1,200 since 2007-08 in real terms. But the fall has been largest for the richest fifth of households (6.8 per cent), according to the ONS. In contrast, after accounting for inflation and household composition, average income for the poorest fifth grew 6.9 per cent over the same period.

The overall impact of tax and benefit changes is that income is being shared more equally between households. In 2011-12, before taxes and benefits, the richest fifth had an average income of £78,300 per year, compared with £5,400 for the poorest fifth – a ratio of 14 to 1. This is lower than the ratio of 16 to 1 in 2010-11. The change is down to rising tax thresholds, which mainly benefit the worse-off, higher national insurance contributions, and reductions in child tax credits for the better-off. Earnings from private pensions and investments are also down. The Gini coefficient, the measure of income inequality where 100 per cent represents all wealth in the hands of one person and 0 per cent signals completely even distribution, eased to 32.3 per cent in 2011-12, down from 33.7 per cent in 2010-11 and its lowest level since 1986. This, again, is due to incomes falling at the top but increasing for the poorest fifth.

Unless a new war in the Middle East sends oil prices haywire or the eurozone explodes again, the broad backdrop for the two years until the next election should be gently falling inflation and growth edging up to around 2 per cent a year. Wages will close the gap on the cost of living, and rising house prices will lift the mood even as the pace of government spending cuts picks up. This is a worry for Labour. Maybe it should be talking more about the Chancellor's failure to eradicate the deficit, rather than talking up a "crisis" that will be receding in people's minds by the time we go to the polls.

Hamish McRae is away.