Britain’s new Prime Minister Liz Truss delivers a speech outside Downing Street in London, Britain on September 6, 2022.
Toby Melville | Reuters
LONDON — Britain’s new Prime Minister Liz Truss faces a confluence of economic challenges, but will have to balance her own ideals with the country’s immediate needs.
Truss last week announced an emergency tax package involving capping annual household energy bills at £2,500 (£2,891) for the next two years, with an equivalent guarantee for businesses over the next six coming months and additional ongoing support for vulnerable sectors. .
The plan is expected to cost the Treasury more than £130billion, with new finance minister Kwasi Kwarteng due to explain how it will be funded later this month, but is widely seen by economists as a positive step to limit the inflation and reduce the immediate effects. risk of recession.
Former finance minister Rishi Sunak’s energy rebate scheme for households will remain in place, while the Bank of England will establish a liquidity facility to help firms in the wholesale energy market make in the face of extreme price volatility.
The fiscal package remains “pivotal” to the UK’s growth outlook, according to Modupe Adegbembo, G-7 economist at AXA Investment Managers, who suggested in a research note on Monday that support for real incomes and growth “will likely be enough to prevent the economy sliding into a prolonged recession.”
UK GDP rose 0.2% month on month in July, official figures showed on Monday, below consensus expectations for a 0.4% expansion. GDP contracted by 0.1% in the second quarter of 2022, and Adegbembo suggested the extra public holiday this month for Queen Elizabeth II’s funeral could tip the UK into a technical recession this quarter .
The announcement prompted major banks to quickly reassess their inflation projections. Barclays now expects inflation to end 2022 at just under 9%, well below the peak of 13.3% forecast by the Bank of England, and the UK lender has cut its inflation forecast CPI for 2023 from 9% to 5.5%.
UK inflation cooled unexpectedly in August, new data showed on Wednesday, so the Bank of England The Monetary Policy Committee could revise its outlook. However, economists were cautious before calling the spike, with some speculating that last month’s reading may have been a “fluke” on a broader upward trajectory.
Food and non-alcoholic beverage inflation reached 13.1%, further compounding the daily difficulties facing household finances.
“While the first-order impact of ‘Trussonomics’ will be to reduce inflation over the next twelve months, the sheer magnitude of the stimulus is likely to add to inflation over the medium term, pointing to a terminal rate higher than the (Bank of England) rate that MPC had already priced in,” said Paul Hollingsworth, Chief European Economist at BNP Paribas.
“Indeed, we note that the MPC is even further behind the market’s implied terminal rate than when it began its tightening cycle.”
Although details are expected to be announced later this month, the government is expected to fund the difference resulting from the price cap through borrowing, rather than a one-off tax on energy companies proposed by opposition parties.
“A package financed by the issuance of public debt would not be without consequences for the markets and should be taken into account by the BoE when deciding on the operational details of its QT [quantitative tightening] programme, in particular the size of active sales and the start date,” Barclays UK chief economist Fabrice Montagne said in a note last week.
Inflation and tight labor market
The Bank of England has postponed its next monetary policy decision until Thursday September 22 due to the death of the British Queen. The Bank launched its biggest interest rate hike in 27 years in August and is expected to opt for another 75 basis point hike this month.
“Following the announcement of the energy bill support program, we have increased our discount rate forecast; we now expect rates to reach 3.5% by the end of the year,” he said. said Adegbembo of AXA.
“While the package is intended to reduce headline inflation, the boost to growth it will provide leaves the Bank of England with more work to ensure inflation returns to target.”
AXA expects a 75 basis point hike this week, in line with market expectations, with further hikes of 50 basis points expected in November and December.
Truss strongly criticized what she saw as the Bank of England’s failure to nip inflation in the bud during her Conservative Party leadership campaign, and reportedly considered a review of her mandate.
Governor Andrew Bailey has repeatedly asserted the Bank’s insensitivity to political pressure, but the BNP’s Hollingsworth suggested that with inflation so high, “the optics of underdelivery are different in the current environment” .
The Truss government and central bank also have to deal with a historically tight labor market, with UK unemployment at its lowest level in 48 years and economic inactivity at its highest level in five years. , fueling fresh fears that inflation is taking root in the UK economy. .
Real wages—adjusting inflation—excluding bonuses fell 2.8% in the three months to the end of July.
During his campaign, Truss argued for tax cuts to spur growth and argued for the controversial theory of “trickle down” economics.
She vowed to reverse Sunak’s rises in corporation tax and National Insurance – an income tax – which had been rolled out to bolster public finances to directly address the cost crisis. life.
Scrapping the two policies is expected to cost the public treasury around £30billion, with Kwarteng due to detail its mini-budget later this month.
The energy price freeze and sweeping tax cuts have drawn criticism for disproportionately helping the country’s wealthiest households.
The Resolution Foundation, an independent think tank focusing on the living standards of low- and middle-income households, projected that the Comprehensive Support Scheme would benefit the highest income decile of the population by an average of £4,700 a year , while the poorest decile would benefit from receiving £2,200.
Although Kwarteng’s mini-budget will offer more detail on how the tax cuts and energy package will be funded, many commentators and political opponents have suggested that Truss’s opposition to levying windfall taxes on Oil and gas companies – which have made record profits due to skyrocketing energy prices – mean that costs could well be recouped from taxpayers and from cuts in investment in utilities.
Truss has repeatedly rejected the idea of direct government intervention to cap household energy bills during the election campaign, only to announce the new one-off tax package a week later.
Economists will be watching for any signs of further turnaround to come as the new prime minister weighs his economic principles against the country’s precarious position.