The Cost of Living Crisis: Global Inflation Hits Consumers

Khan Capital | June 2022

US CPI has reached 9.1% for June 2022, the highest reading since November 1981. UK inflation has surpassed 9% and is forecast to reach double digits by autumn. Eurozone inflation stands at 8.6%. Across the developed world, the cost of food, energy, housing, and essential services is rising at a pace that is eroding living standards, reshaping consumer behaviour, and creating political instability that will define elections for the next two years. The cost of living crisis is no longer a headline; it is the lived experience of hundreds of millions of households in the world’s wealthiest economies.

The Anatomy of the Squeeze

The cost of living crisis is driven by the convergence of multiple inflationary forces that, individually, would have been manageable but, combined, have produced the most severe erosion of purchasing power in a generation.

Energy. The Russia-Ukraine war has driven European natural gas prices to ten times their historical average. Brent crude has traded above $120 per barrel. Gasoline prices in the United States have exceeded $5 per gallon for the first time in history. Energy costs feed through to every other price in the economy: food (through fertiliser and transportation costs), manufacturing (through industrial energy consumption), and services (through heating and cooling costs). For lower-income households, who spend a proportionally larger share of their income on energy, the impact is regressive and acute.

Food. Global food prices, as measured by the FAO Food Price Index, reached their highest level in recorded history in March 2022 before partially retracing. The war in Ukraine disrupted exports from one of the world’s largest grain-producing regions. Fertiliser costs, which are tied to natural gas prices, have surged, raising input costs for farmers globally. Supply chain disruptions from COVID-era bottlenecks continue to affect food distribution. The result is food price inflation that exceeds headline CPI in most economies and that disproportionately affects the poorest households and the most vulnerable nations.

Shelter. Housing costs, which represent the largest single expenditure for most households, have risen sharply across the developed world. In the United States, shelter inflation (which includes both rents and owners’ equivalent rent) is running above 5% and, due to measurement lags, is expected to remain elevated through 2023 even if new lease rents begin to decline. Mortgage rates have doubled from approximately 3% to over 6%, simultaneously reducing affordability for prospective buyers and locking existing homeowners into their current properties (the “lock-in” effect), which constrains supply and supports rents.

Wages. Nominal wages are rising at their fastest pace in decades, driven by a tight labour market in which job openings far exceed available workers. But real wages (nominal wages minus inflation) are declining for the majority of workers: wages are rising at 5%, but prices are rising at 9%. The distinction between nominal and real wage growth is the essence of the cost of living crisis: households are earning more in absolute terms but falling behind in purchasing power terms.

The Policy Response and Its Limitations

Governments and central banks are responding to the crisis with different tools and different constraints.

Central banks are raising interest rates aggressively, with the Fed delivering 75-basis-point hikes and the ECB preparing to exit negative rates. Rate hikes are the textbook response to inflation, but they address demand-driven price pressures, not supply-driven ones. Raising rates will not produce more oil, grow more wheat, or build more houses; it will reduce demand by making borrowing more expensive, slowing the economy, and eventually raising unemployment. The cure, in other words, involves its own form of economic pain.

Governments are deploying fiscal measures: energy price caps (in Europe), fuel duty cuts, direct payments to households, and targeted subsidies for the most vulnerable. These measures provide short-term relief but create their own complications: they are expensive (increasing fiscal deficits at a time when bond markets are already under stress), they can be inflationary (subsidies that maintain demand in the face of constrained supply perpetuate the price pressures they are designed to alleviate), and they create political expectations that are difficult to unwind once the crisis passes.

What the Market Is Misunderstanding

The distributional impact is the political story. Headline inflation numbers are averages that obscure enormous variation across income levels. Lower-income households spend a larger proportion of their income on food, energy, and shelter, the categories with the highest inflation. Their “experienced” inflation rate is significantly above the headline CPI figure. This distributional reality is driving political consequences: incumbents are losing elections, populist movements are gaining support, and the social contract between governments and citizens is being strained in ways that will influence policy for years.

The consumer spending data is misleading. Aggregate consumer spending has remained resilient, but this resilience masks a bifurcation. High-income households, whose wealth has been bolstered by equity market gains and whose fixed-rate mortgages insulate them from rate increases, continue to spend. Lower-income households are drawing down savings, increasing credit card usage, and shifting spending from discretionary goods to essentials. The resilience of the aggregate data is being driven by the top quintile while the bottom quintile is under genuine financial stress.

The emerging market dimension is the most dangerous. While the cost of living crisis in developed economies is severe, it is potentially catastrophic in food-importing emerging markets. Countries that depend on imported grain and energy, and that have limited fiscal capacity to subsidise their populations, face the risk of food insecurity, social unrest, and political instability. Sri Lanka’s economic collapse and political revolution in 2022 is not an isolated event; it is the leading edge of a crisis that could affect dozens of vulnerable nations.

Implications for Investors

Consumer staples and essential services offer defensive positioning. Companies that provide necessities (food, utilities, healthcare, basic consumer goods) benefit from inelastic demand that persists even as discretionary spending contracts. Pricing power within staples varies, however: companies that can pass through input cost increases without losing volume will outperform those that cannot.

Consumer discretionary faces a structural headwind. As real incomes decline, spending on non-essential goods and services (restaurants, travel, apparel, electronics) comes under pressure. The consumer discretionary sector’s underperformance in 2022 reflects this dynamic, and the headwind will persist as long as real wages remain negative.

Inflation-linked bonds (TIPS, UK linkers) provide explicit protection. With inflation running at multi-decade highs, securities that provide inflation-indexed returns offer a hedge that is both effective and attractively priced, particularly at current real yield levels.

Emerging market differentiation is essential. Commodity-exporting EMs (Gulf states, Latin American energy producers) benefit from the same price increases that are crushing commodity-importing EMs (South Asia, Sub-Saharan Africa). The performance dispersion within the EM universe is extreme and will widen further if the cost of living crisis persists.

Conclusion

The cost of living crisis of 2022 is the most severe erosion of purchasing power in the developed world since the stagflation of the 1970s. Its causes are multiple (energy, food, shelter, wages), its distributional impact is regressive (hitting the poorest hardest), and its consequences are both economic (reshaping consumer spending, corporate margins, and monetary policy) and political (threatening incumbents, empowering populists, and straining the social contract). For investors, the crisis is a reminder that inflation is not merely a macroeconomic variable; it is a force that reshapes societies, redistributes wealth, and redefines the relationship between governments and the citizens they serve.

Key Takeaways

• US CPI has reached 9.1% (the highest since 1981), UK inflation exceeds 9%, and eurozone inflation stands at 8.6%, driven by the convergence of energy, food, shelter, and wage pressures that are eroding purchasing power across the developed world.
• Real wages are declining for the majority of workers: nominal wages rising at 5% are outpaced by prices rising at 9%, creating a squeeze that disproportionately affects lower-income households who spend more on food and energy.
• Central bank rate hikes address demand-side inflation but cannot resolve supply-driven price pressures from the energy crisis and food supply disruptions, meaning the policy cure involves its own form of economic pain.
• The emerging market dimension is potentially catastrophic: food-importing nations with limited fiscal capacity face food insecurity, social unrest, and political instability, with Sri Lanka’s 2022 collapse serving as a leading indicator.
• Consumer spending resilience is misleading: aggregate data is driven by high-income households while lower-income households are drawing down savings and shifting spending from discretionary goods to essentials.

Related Reading

The cost of living crisis was fuelled by the energy shock covered in The Energy Crisis: European Gas Prices Hit Record Highs and the broader conflict in Russia Invades Ukraine. The inflationary dynamics were first debated in The Inflation Debate: Team Transitory vs. Team Persistent. For the central bank response, see The Fed’s Most Aggressive Hiking Cycle.