In a brief statement to the House of Commons on the crisis in the cost of living in the UK, Rishi Sunak managed to alleviate two economic problems, but at the cost of worsening a third.
The good news is that his actions are likely to reduce the peak rate of inflation this year and help UK households cope with the immediate cost of living. But they will also deliver the hottest inflation potatoes directly to the lap of the Bank of England.
The chancellor also left huge questions about what will happen to household support next year.
The first effect of the measures is likely to be mechanical, reducing the expected rise in inflation and potentially avoiding the tremendous growth of more than 10 percent this fall.
If household energy bills rise to an average of around £ 2,400 a year instead of the level of £ 2,800, which Ofgem said this week is likely, inflation is unlikely to rise as much as previously expected.
This is uncertain, as the National Statistics Office has not announced whether it will classify the support as a rebate that would limit the rise in inflation or as income support that will not affect the measured inflation.
Although this difference is largely semantic – as both discounts and income support make households equally equal – most economists believe the ONS will decide that the package will reduce inflation.
Ben Nabaro, a chief British economist at Citi, said he expected the 400-pound rebate to cut the peak inflation rate in October by 1.3 percentage points from where it would otherwise be.
He said that would mean that “consumer price inflation will peak at an annual rate of 9.5 percent” and retail price inflation of 11.5 percent. This will reduce the cost of servicing government debt by £ 500 billion, which is linked to RPI.
But while households will be supported by universal support, along with more targeted assistance for those receiving income-verification benefits, pensioners and people with disabilities this financial year, economists noted that, on average, households will still be more prosperous. bad situation.
Paul Dales, chief British economist at Capital Economics, estimates that the average real disposable income of households will now fall by 1% in 2022, although this is an improvement over the 2% decline expected before the chancellor made his statement.
The big question is whether the package will increase consumer spending and encourage companies to raise prices, which will fuel inflation next year, leaving households ultimately in a better position.
An aide to the chancellor agreed that the incentives offered by the package could be seen as inflationary, but said net support was not so great.
Instead, Sunak shifted the difficult task of controlling inflation to the central bank. “I know that the governor and his team will take decisive action to bring inflation back to target and ensure that inflation expectations remain firmly anchored,” he said.
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Economists have agreed that Sunak’s actions will act as an incentive, making the BoE more likely to raise interest rates faster and further than previously expected, but they disagree on the degree of monetary tightening needed to compensate. this fiscal boost.
Calum Pickering, a senior economist at Berenberg Bank, described the chancellor’s package as “wrong” because it will increase demand at a time when private wages are rising. . . and most households have excess savings accumulated during the blockade. ‘
“Keep it up and eventually the BoE will be forced to control inflation by raising interest rates well above neutrals and causing a recession,” he added.
But Robert Wood, the UK’s chief economist at Bank of America, said the package would only require the BoE to impose “modestly higher interest rates” as tax revenues also rise unexpectedly fast.
Nabaro, who also believes the package will put only slight pressure on the central bank to raise inflation, said hints of further tax cuts in the autumn budget are more worrying in terms of the likely impact on interest rates.
“The question now is whether the chancellor will return before the end of the fiscal year. That seems more and more plausible, “he said.
Economists also disagree on the exact level of incentives Sunak has provided. He told the House of Commons that the package would cost £ 15bn, offset by an unforeseen £ 5bn tax on profits in the North Sea.
However, some economists said the chancellor had underestimated the overall stimulus in his package because he failed to account for abandoning his February plan to repay £ 40 a year for a five-year £ 200 loan to help households pay their bills. for energy.
Sandra Horsfield, an economist at Investec, said: “The real fiscal support now for what was put on the table in February [is] by about £ 5 billion more [than £15bn]”
The Chancellor could plausibly claim that in the future the contingency tax will continue to raise around £ 5 billion a year until his exclusion clause is activated at the end of 2025. He said this will only happen if energy remained high, although it failed to specify a price threshold at which the tax would be phased out.
The chancellor himself noted that the problem of inflation is becoming wider, with rising prices exceeding 3 percent in four of the five categories of goods and services. As a result, economists and financial markets now expect interest rates to be significantly higher.
Alan Monks, the UK’s chief economist at JPMorgan, said the package would help “steer the economy out of recession” in the short term, but would come at a rate of interest rates higher than the current 1 percent.
“This would mean that the BoE will continue to rise at each meeting until November, taking levels to 2% by the end of the year and then to 2.75% by next August,” he said.
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