By Daniel Hunter

After a ‘torrid’ five years, there is now light at the end of the tunnel for the hard pressed consumer.

According to a special report out by the Ernst & Young ITEM Club, changes to the personal tax system and falling inflation will bolster the wallets of the average earner by £482 this year and £624 in 2013, which will feed through to a steady pick-up in spending on the UK’s high streets.

Consumers will feel better off by the end of the year

The ITEM Club consumer spending special report says that, provided oil prices continue to ease, inflation is likely to move back towards the 2% target by the end of the year, bringing prices into line with wages.

This, combined with an increase in the personal tax allowance, will see real take home pay stabilising this year and accelerating into 2013, which will benefit the vast majority of consumers.

“After the tightest squeeze on consumer incomes in a generation, the worst is now behind us and most people should start to feel a bit better off by the end of the year," Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club commented.

"Wage growth will finally begin to outpace inflation and our pay packets will also be boosted by the tax changes announced in the Budget. Only the top 10% of the income distribution, earning above £36,000, and the bottom 10%, who aren’t liable for income tax, won’t benefit from the increase in the personal allowance.”

It will be a slow and steady recovery on the high street

According to the report, stronger household finances and an improving economic outlook will result in a gradual improvement in consumer spending from the middle of this year, whilst tourism from the Olympics will provide an additional boost.

Spending growth is forecast at 0.8% this year and 1.1% in 2013. However, ITEM Club warns that it will be a slow recovery for the high street. Spending will be constrained by consumers paying down debt, and won’t return to pre-recession levels until 2015.

ITEM Club says the debt to income ratio was 151% at the end of 2011; down from the 2008 peak of 173%, but still much higher than in the US at 117%. The report warns that the cost of servicing this debt is also likely to increase significantly once record low interest rates start to rise.

“It’s an improving outlook for the UK high street but it’s going to be a slow and steady recovery," Goodwin explained.

"Rather than splashing their cash, we’re expecting to see conscientious consumers keeping a relatively firm grip on their purse strings. Instead, they are likely to focus on trying to pay down debt, taking advantage of a 12 month window before interest rates start to rise again."

High-tech goods will win the biggest share of our wallets

With consumer spending on a steady upward trajectory, ITEM Club says that audio visual goods — such as TV’s, mobile phones and broadband - will continue to perform strongly, with the Recreation & Culture and Communications sectors winning the battle for the biggest share of our wallets. Rapid advancements in technology and falling prices will continue to underpin strong demand and will see both of these sectors grow by 4.2% this year.

As the wider economic outlook improves and real household income growth picks up, ITEM expects spending in the more income elastic sectors to strengthen, such as Cars and Hotels & Restaurants, albeit slowly. Growth is forecast at 0.7% and 0.3% respectively for this year, rising to 2.6% and 1.1% by 2015.

“The squeeze on consumer spending has accelerated some of the broader shifts that we’ve started to see over the last few years," Ed Hudson, head of consumer products at Ernst & Young commented.

"Our clients are telling us that consumers have become a lot savvier and are focussed on purchases that offer the best value, rather than just the lowest price. It’s why high end goods from TVs to fashion items are more prominently displayed in the supermarket aisles, as quality, longer lasting branded products win the day.

“It’s still a tough trading environment for UK retailers and there are going to be winners and losers on every high street as businesses adapt to the ‘new normal’.”

Major risks remain

“We still need to keep our fingers tightly crossed," Goodwin concluded.

"The Eurozone crisis continues to cast a long shadow and consumer confidence could easily take another hit if the situation worsens, particularly if unemployment nudges up. We are optimistic, but conditions on the high street will remain fairly fragile until a more sustainable recovery takes hold.”

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