6 September 2022

From energy prices to inflation: how Liz Truss plans to tackle the economy

The new Prime Minister will take charge of a country facing huge economic challenges.

Liz Truss is entering Downing Street during arguably the most difficult period of the Conservatives’ 12 years in office. She is taking control of a country still recovering from a pandemic, whose population is reeling as inflation surges, and whose economy is expected to fall into recession before the end of the year.

Fires are raging in every part of the economy – here are five of the most urgent.

Energy prices

Energy prices are the biggest, most immediate crisis Britain faces: last month Ofgem, the energy regulator, announced its price cap will rise to £3,549 per year for a typical home from October. That will push the number of households in fuel poverty up from 6.5 million to 8.5 million, according to the charity National Energy Action.

Yesterday (Sunday 4 September) Truss told the BBC that she would announce measures to address the energy crisis “within one week”, and an announcement is expected on Thursday. Many in the energy industry expect state intervention to impose a limit on price rises, as has already happened in other countries.

Unlike the leaders of other countries, Truss has (in an interview with LBC) ruled out energy rationing – although the government’s latest “worst-case scenario” planning raises the risk of blackouts without limitations on demand.

Truss’s answer to the supply problem may, according to the Times last week, come in the form of increased oil and gas drilling. Kwasi Kwarteng and Jacob Rees-Mogg – who are expected to be named chancellor and business secretary, respectively – have spent recent weeks negotiating to increase the amount of gas we import from Norway, and the amount that we produce domestically. This will have little effect on bills, however: while contracts for UK offshore wind have fallen to their lowest ever, at £37.40 per megawatt hour, last week the consultancy Energy Aspects said it expected gas prices to hover between €270-€340 per megawatt hour.

Inflation

Inflation – which began in pandemic-related supply chain issues and shifting demand – is being supercharged by energy prices, extreme weather and Brexit. The Bank of England has suggested inflation could hit 13 per cent next month, but economists at Citi bank believe it could hit 18 per cent in early 2023, and those at Goldman Sachs have suggested it could rise to 22 per cent early next year.

The main item in Liz Truss’s pitch to the Conservative Party members that elected her was a £30bn programme of tax cuts (although some economists have estimated the cost as being closer to £50bn a year), including a VAT rate reduction of between five and ten percentage points, from its current level of 20 per cent. This would give people more disposable income – but the Institute for Fiscal Studies has pointed out that more disposable income creates more demand, which pushes up prices; the think tank said targeted help for households that need it the most would be a better way to cut taxes.

Truss has also taken aim at the Bank itself, blaming it for failing to start raising interest rates soon enough to control inflation. Her solution is to re-examine the Bank’s independence: “I want to change the Bank of England’s mandate,” she has said. The subtext seems to be that she wants remove the Bank’s independence, effectively putting the government in charge of interest rates, which Truss has indicated she wants to be as high as 7 per cent. This looks likely to backfire: economists have warned any such change would weaken the pound – which would make importing more expensive, which would increase inflation.

Employment

If households are facing an unpleasant winter, for small firms it will be a potentially devastating one. Not only are they not covered by the energy price cap, meaning they face increases in bills that will entirely wipe out their profits and in many cases prevent them from trading. Even those businesses lucky enough to be on a fixed-price deal for energy face steeply rising costs, however, due to a tight labour market – when workers are in shorter supply than the number of jobs. In the first quarter of this year, for the first time ever there were fewer unemployed people than there were vacancies in the UK. That means employers have to offer higher wages to attract workers, which means increased inflation. This is partly because many foreign workers went home during the pandemic and didn’t come back, and partly because of an exodus of older workers out of the workforce – both of which mean there are now almost 600,000 fewer workers in the UK than there were before the pandemic.

Truss has hardly been sympathetic to the plight of businesses: rather than making suggestions to support, for instance, the two million people living with long Covid, according to one survey, many of whom struggle to work, a leaked recording showed her complaining that low UK productivity was “partly a mindset and attitude thing… Actually what needs to happen is… more graft.”

Strikes

With workers struggling to pay their bills, unions are mobilising: this week alone criminal barristers, staff at the government’s Department for Business, Energy and Industrial Strategy (BEIS), Scottish bin workers, staff at four colleges in north-west England, Scottish teachers and Royal Mail staff are all going on strike, while more action is planned by rail workers.

In July, as union dissatisfaction rumbled, Truss vowed to introduce rules outlined in the Conservatives’ 2019 manifesto that will introduce extensive reforms to trade union laws. They include a higher threshold to the number of workers who vote in ballots, a limit to the number of times workers can walk out and a guaranteed minimum level of service during strikes. “We need tough and decisive action to limit trade unions’ ability to paralyse our economy,” she said.

Truss did announce a policy last month (regional pay boards that would tie pay to the local cost of living) that would approach the main issue causing the strikes: the steep fall in real-terms pay in both the private and public sector. But it was withdrawn within hours.

Housing crisis

There are three certainties in life: death, taxes and the fact that a Conservative government will do everything in its power to prevent UK house prices from falling. In May 2010, when David Cameron was elected, the average UK house price was £170,846, according to the Office for National Statistics. By June this year, it was more than £286,000, a rise of 67 per cent. That means the average home in England is now 9.1 times the average annual salary, up from 7.9 times in 2020. And that’s without taking into account rental homes: a recent survey by Propertymark showed the number of homes for rent fell by 49 per cent between March 2019 and this year. That has pushed rents to record highs, according to Rightmove, which showed the average rent outside London has risen almost 12 per cent in the past year, while in the capital it has risen almost 16 per cent.

Truss has outlined reforms to the market that would allow banks to use a history of rent payments as proof that buyers would be able to pay a mortgage (rent payments are often more expensive than mortgage payments), and she has said she will “put power back in local councillors’ hands”, giving more control to local planning committees. These have been welcomed by the property industry.

But the sector is less enamoured of her plans for the Bank of England: raising interest rates to 7 per cent could be “apocalyptic” for the housing market, one estate agent has said, because pushing up borrowing rates will increasing mortgage payments, which will cause fewer people to buy homes. For a party that prides itself on having created a “nation of homeowners”, clearly, this is less than desirable.