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Confronting the reality of the UK energy crisis

Grim news about the UK economy continues to grow. Last week, the Bank of England forecast a 15-month recession, with inflation at over 13 percent. The energy price cap, which limits how much households can be charged, is now expected to rise 80 percent in October from current record levels, forcing many to face a difficult choice between heating and eating during the winter. Mortgage and rental costs are also rising. But with the government paralyzed as it awaits the outcome of a conservative leadership contest that still ignores the magnitude of the problem, there is still no clear and realistic strategy for the short-term cost of living – just as the most vulnerable need it most.

The UK is facing the worst period of stagflation – low growth and high inflation – since the 1970s. A reliance on natural gas imports and a slow workforce recovery after the pandemic means inflation in the UK is a toxic mix of the energy-driven type facing continental Europe and wage pressures in the US. Underlying the BoE’s grim forecast was the equally dismal calculation that in order to lower inflation, interest rates had to be raised enough to cool the job market and investment, causing a downturn in the process.

Now that the central bank is aware of the danger of continued high inflation, fiscal policy will have to be cautious as it offsets the cost of living crisis when resources are tight. Weaker growth will reduce the fiscal space the Treasury could have squeezed, while the government has already pledged a hefty £37bn for various living expenses. Moreover, efforts to support households – whether through tax cuts or direct payments – will further fuel inflation, which in turn will be cushioned by tighter monetary policy.

So, like the BoE, the government has to make its own grim calculation — about how to share the pain of skyrocketing inflation. While the Tory leadership candidates have refused to face this reality, whoever wins will have to do so. With prices rising, after-tax household incomes are expected to fall the most in real terms in more than 60 years. Rising energy and food prices will continue to hit the vulnerable hardest, so targeted support for them should be the priority, albeit marginally inflationary.

Getting money out the door quickly and efficiently will be crucial. Energy bills could now reach £4,300 a year in January, following the decision to pass on increases in wholesale prices more quickly. Liz Truss has shunned ‘handouts’ to households, preferring to reverse increases in national insurance and scrap green taxes. Rishi Sunak has not only reduced VAT on energy but has also suggested expanding the direct payments he has provided as chancellor.

Cuts in taxes and energy VAT will put more money in the pockets, but will only tinker around the edges of the problem. Reversing the increase in national insurance will do more for the higher earners. Building on Sunak’s support package in May – including payments to people on means-tested benefits, in addition to the disabled and retirees – may be the most viable immediate solution. It should be scaled up (it was based roughly on a £2,800 energy price cap) and better targeted; further payments to wealthier households are also difficult to justify.

Each package should be accompanied by efforts to save energy and curb demand in winter. With bills set to remain high next year, the entire structure of the price cap and support for poorer households will also need to be overhauled. It is time for both prime ministerial candidates to deal with the reality of the crisis and draw up action plans. For those who take it over in September, it will be the most urgent item in their in-tray.

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