Confronting the reality of the UK energy crisis

Grim news about the UK economy keeps mounting. Last week, the Bank of England forecast a 15-month recession, with inflation peaking at more than 13 per cent. The energy price cap, which limits how much households can be charged, is now forecast to soar 80 per cent in October from today’s record levels, pushing many into a dire choice between heating and eating over the winter. Mortgage and rental costs are also rising. Yet with the government paralysed as it awaits the outcome of a Conservative leadership contest that is still ignoring the scale of the problem, there is still no clear and realistic near-term cost of living strategy — just when the most vulnerable need it the most.

The UK faces its worst bout of stagflation — low growth and high inflation — since the 1970s. A reliance on natural gas imports and a sluggish post-pandemic recovery in its workforce means UK inflation is a toxic mix of the energy-driven type facing continental Europe and the wage pressures at play in the US. Underlying the BoE’s stark forecast was the equally bleak calculation that in order to bring inflation down it needed to lift interest rates enough to cool the jobs market and investment, engineering a downturn in the process.

With the central bank now alive to the danger of persistently high inflation, fiscal policy will have to tread carefully as it offsets the cost of living crisis when resources are tight. Weaker growth will shrink any fiscal headroom the Treasury might have had, while the government has already pledged a hefty £37bn across various cost of living packages. Moreover, efforts to support households — whether by tax cuts or direct payments — will add further fuel to inflation, which will in turn be met by tighter monetary policy.

So, like the BoE, the government must do its own grim calculus — on how to share out the pain from sky-high inflation. While the Tory leadership candidates have declined to confront this reality, whoever wins will have to do so. With prices moving higher, post-tax household incomes are expected to fall by the most in real terms in more than 60 years. Soaring energy and food prices will continue to hit the vulnerable the hardest, so targeted support to them must be the priority, even if it is inflationary at the margin.

Getting money out of the door quickly and efficiently will be crucial. Energy bills could now hit £4,300 a year by January, after the decision to pass on rises in wholesale prices faster. Liz Truss has eschewed “handouts’’ to households, preferring to reverse rises in national insurance and scrap green levies. As well as cutting VAT on energy, Rishi Sunak has hinted at extending the direct payments he provided as chancellor.

Cuts to levies and energy VAT will put more money in pockets, but will only tinker at the edges of the problem. Reversing the national insurance increase will do more for higher earners. Building on Sunak’s package of support in May — which included payments to those on means tested benefits, alongside the disabled and pensioners — may be the most viable immediate solution. It would need to be scaled up (it was based roughly on a £2,800 energy price cap) and better targeted; further payments to richer households too would be hard to justify.

Any package would need to come alongside efforts to conserve energy and curb demand over the winter. With bills set to remain high into next year, the whole structure of the price cap and support for poorer households also needs to be reviewed. It is time both candidates for prime minister started to engage with the reality of the crisis and set out plans for action. For whoever takes over in September, it will be the most pressing item in their in-tray.

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