Truss’ energy plans could curb spike in inflation

Image © Photo by Simon Dawson / No 10 Downing Street.

A plan to cap UK energy bills could reduce the expected October spike in UK inflation.

Britain’s new prime minister plans to freeze energy bills for millions of households this winter, reports say, a move that could cut UK inflation rates by up to four percentage points.

Liz Truss could announce an effective cap on energy bills as of this week.

Underlying inflation would nonetheless remain stubbornly high and invite further interest rate hikes from the Bank of England, according to independent research firms Capital Economics.

Ahead of confirmation that Truss had won the competition for the next leader of the Conservative Party, the Telegraph reported that a freeze of some form is now expected.

“The implications would depend on the details, but it could mean that CPI inflation is around 4 percentage points lower than it would otherwise be,” says Paul Dales, chief UK economist at Capital. Economics, about an energy bill cap.

This means that inflation could rise from 10.1% in July to a peak of 10.5%, instead of the 14.5% currently forecast by Capital Economics.

It is estimated that any price cap plan would cost between £70-100bn, or 3-4% of GDP, which would be financed by borrowing.

In October, the average annual energy bill will rise from £1,971 to £3,549, which would lead to a spike in inflation.

The Bank of England said in August that it expected inflation in the UK to now peak at “around 13%”.

Bank of England UK Inflation Forecast

Above: The Bank of England’s August inflation forecast. Bank of England image.

We won’t have to wait long for details, as Truss said in a BBC interview over the weekend, a support package would be announced within a week.

If energy bills were to be capped, Capital Economics says real GDP would not “fall as much”.

“We doubt that Truss will be able to prevent a recession. But his policies could limit its depth and duration. year,” says Dales. .

Although headline inflation is shielded from another energy-induced shock, underlying inflationary pressures in the economy could be reinforced by Truss’ plans.

As households find their financial outlook improving markedly, they may be inclined to spend more, particularly if a further £30 billion in tax cuts are granted, which Truss said she would introduce “as soon as first day”.

This surge in “underlying inflation” would put additional pressure on the Bank of England to raise interest rates.

Above: The Bank of England’s August inflation forecast. Bank of England image.

Capital Economics expects the bank to rise to 3.0%, although the market is currently pricing in a terminal discount rate of 4.30%.

“The risks are that rates have to go up further,” says Dales.

Meanwhile, Truss is expected to secure permanent independence from the Bank of England, allaying fears among economists and analysts that Liz Truss could meddle with the central bank.

write in flightKwasi Kwarteng, who is heavily favored to be the country’s next chancellor, said “we also remain fully committed to the independence of the Bank of England.”

Analysts have made much of Truss’ Commitment to review the Bank of England’s mandate, with some suggesting this is a sign the new Prime Minister wants to take a more direct approach to the management of UK monetary policy and undermine the independence of the Bank of England .

“For the first time since Gordon Brown granted it freedom to set interest rates in 1997, the Bank’s independence appears to be under threat,” said Larry Elliott, economics editor at the Guardian in a recent op-ed.

It is understood that threats to the Bank’s independence should be viewed as a risk to the UK’s economic outlook and, by extension, the pound.

Above: Bank of England forecast for UK economic growth. Image source: Bank of England.

“We expect an upcoming war of independence over the Bank of England. This potential battle and the politicization of the UK central bank is likely to create considerable uncertainty which will spook financial markets,” said Nigel Green, Managing Director and Founder of the deVere Group.

“We can expect the pound and the gilt market to react badly to any sense of growing political interference,” he adds.

But Kwarteng’s intervention on the day Truss is expected to be announced as the next leader of the Conservative Party confirms fears that some have indulged too much in speculation about what a post as Prime Minister Truss means.

Kwarteng acknowledged “the important work” the Bank “has in the coming months to bring down inflation. We believe coordination between monetary policy and fiscal policy is crucial.”

What this coordination looks like, however, is unclear.

“Predictions are not fate,” adds Kwarteng. The Bank of England dominated the front pages of newspapers in August when it released forecasts showing inflation to reach “around 13%” before the end of 2022.

Carol N. Valencia