The cost of living crisis will drag average earnings back to the same level as 2003 as Britain faces the biggest slump in living standards for a century, economists have warned.

Real disposable incomes will slump 10pc over the next two years in a crushing blow to household finances that will severely damage the economy, according to the Resolution Foundation.

An extra 3m people will fall into absolute poverty as a result of the cost of living crunch.

Lalitha Try, researcher at the Resolution Foundation, said the outlook for living standards is “frankly terrifying” as households brace for a 80pc surge in the energy price cap in October and further jumps next year.

She said: “No responsible government could accept such an outlook, so radical policy action is required to address it.

"We are going to need an energy support package worth tens of billions of pounds, coupled with increasing benefits next year by October’s inflation rate.”

The Foundation said the latest setback to pay will cause average weekly earnings to retreat to levels seen in 2003.

Soaring energy bills have driven inflation up to a 40-year high of 10.1pc but prices are expected to soar even faster in the coming months. Inflation could hit more than 22pc if gas prices remain at high levels, according to Goldman Sachs.

The new Prime Minister — widely expected to be Liz Truss, the current Foreign Secretary — is likely to be forced into immediate action to help households as energy suppliers propose a freeze on the price cap.

Ms Truss has promised tax cuts for hard-hit households but economists have warned she will need to go much further as recession fears mount.

The Resolution Foundation said typical real incomes will be 7pc lower at the end of the current Parliament in 2024-25 than the start in 2019-20, the “first time on record that Britain has got significantly poorer” over a term.

It said the setback for households is driven by the inflation squeeze, as well as 15-year economic stagnation caused by weak productivity growth.

It came as a household confidence gauge went into “freefall” as Britain braces for an unprecedented surge in energy bills this winter.

The confidence indicator, produced by Bank of America, suffered its biggest monthly fall since the first lockdown and is at its lowest level since November 2020.

Its UK economist Robert Wood said: “Crucially for the economic outlook, consumers are more pessimistic about their personal finances than in 2020, unemployment expectations are rising fast, and spending dropping.”

He said the gauge “may soon breach the record low for our series recorded in April 2020”.