Vantage Point: Economic Outlook  

What are the economic consequences of govt's energy policy?

  • To understand how the government's energy policy impacts economic growth
  • To understand how the inflation outlook may have changed
  • To discover how the government's policies may impact interest rates
CPD
Approx.30min
What are the economic consequences of govt's energy policy?
Prime Minister Liz Truss. (Reuters/Hannah Mckay)

The government’s announcement of a package worth more than £100bn to help households and businesses with the spiralling cost of energy is likely to have a positive impact on many lives, but the implications for the wider economy are murkier, and could have longer-term consequences.

The headline figure is that a combination of capping the unit price of energy plus the direct subsidy of at least £400 to every household costs around £140bn, with £5bn of that funded from a previously announced windfall tax on energy companies, and the rest from government borrowing. 

The most obvious way in which this impacts the wider economy, according to Azad Zangana, senior European economist and strategist at Schroders, is that inflation will now be lower than previously feared. 

He says his previous expectation was for inflation to average 10.5 per cent in the UK in 2023, but as a result of the energy measures, he expects the average to be around 7.7 per cent, and inflation to peak this October. 

Zangana says that while we are still likely to have a technical recession, that is, two consecutive quarters of negative GDP growth, “the chances of a longer and deeper recession have reduced materially. The energy policy is a stimulus for the economy and very positive for consumer spending”.

Silvia Dall’Angelo, senior economist at Federated Hermes, elaborated on those points, saying: "Headline CPI inflation – currently running at 10 per cent – now appears to be close to its peak, as the expected increase in coming quarters were largely due to the recent increase in wholesale gas prices, its impact on electricity prices and the pass-through mechanism in place before today’s announcement.

 

"With the new £2,500 cap for utility prices due to come into effect in October, headline CPI inflation will likely peak at about 11 per cent in that month.”

She adds: “The short-term impact on growth should also be positive and significant, although it is unlikely the package will be enough to avert a recession later this year. Elevated inflation – especially in non-discretionary spending items such as energy and food – has already eaten into real incomes significantly and will continue to weigh on consumption in the coming quarters.”

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, is probably more positive than his peers, stating that he feels a recession is now “unlikely”, and that he expects UK inflation to fall rapidly in 2023 and to get back to as low as 2 per cent, which is the Bank of England’s official target. 

He says that food and fuel prices, as represented by commodity prices, are likely to fall in 2023 as the futures markets are already selling those commodities for use next year at prices lower than the current prices.

One example of this is the oil price; data from Wilshire, an index provider, indicates the oil price fell by 10 per cent in August. 

Tombs expects that inflation in the services sector will be “stickier” next year, however – services sector inflation is much more impacted by wage costs.