Economy

It’s time to fix wholesale energy prices

The cost-of-living crisis has been fed by rampant energy prices and poor monetary policy that has contributed to high inflation and higher taxes.

I expect the new Prime Minister to unveil a clear, credible policy backed by immediate action. The first thing to do is tackle energy prices head on.

Some argue that prices should still be allowed to rise, as such market signals will impact behaviour. The reality though is that prices have risen so much that people and firms are already changing behaviour to conserve energy. There is nothing to be gained from letting prices rise further.

The dislocation in energy prices is now such that it makes sense for the government to step in and protect people and firms by fixing wholesale energy prices. This takes the pressure off. It will also allow the Government to focus on guaranteeing future supply. It is a simple measure and it can be executed in a way that keeps the cost to the Government down.

Such a move would remove uncertainty and be positive for business and consumer confidence.

Of course, the measures shouldn’t stop there. Orthodox thinking at the Treasury has failed. Because trend growth is low, the policy approach is that more of the budget deficit is structural not cyclical. This thinking led to austerity a decade ago and has led to higher taxes now. It is akin to being in a hole and digging deeper.

This must be turned on its head. Capping gas prices will help the inflation outlook. So too would lowering taxes on energy and fuel. Liz Truss will suspend the environmental levy. Suspending the 5% VAT on domestic energy also makes sense. Because of the weaker world economy, oil prices have fallen significantly so cutting duties on petrol isn’t necessary.

A cut in income tax by two pence has already been pencilled in for 2024. It should be brought forwards. Also, inflation has dragged many people into higher tax brackets, so raising income tax thresholds and allowances is necessary, though it may take time.

Planned tax hikes such as national insurance and corporation tax must be reversed and business taxes must be cut.

How financial markets will view all this is key. Importantly, in the last few weeks, market expectations for where UK rates will peak have risen sharply but the pound has weakened. The markets are nervous about the economy and about policy options.

Tackling the energy crisis will be seen positively because of its impact on growth. However, it is still unclear how markets will react to a sizeable fiscal package. This creates the need for the Government to change the narrative and expectations.

The message is that monetary policy must get on top of future inflation, while the role of fiscal policy is to stabilise the economy. Fiscal action now is necessary, affordable and non-inflationary. Although borrowing rates have risen the UK can still borrow at very negative real interest rates. Such borrowing needs to help us prevent an unnecessary deep recession – it is sensible planning.

The Prime Minister needs to tear up the current fiscal rules that constrain policy for no obvious benefit. Fiscal rules sound sensible but there have been eight different versions since being introduced by Gordon Brown.

Fiscal discipline is essential. That’s not debatable. The only rule we need is to reduce the ratio of debt to GDP over time, ensuring financial solvency and curbing public spending. Crucially, using fiscal policy effectively makes macro-economic policy more credible. It should also empower the Bank of England to focus on tackling inflation.

Financial markets expect inflation to peak this winter and to decelerate next year. Government action to cap gas prices will improve the outlook. The Bank of England has a credibility gap and a communication problem. They need to address both to get inflation under control.


Dr Gerard Lyons is chief economic strategist at Netwealth

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