Jonathan Marriott, Chief Investment Officer
The passing of Her Majesty Queen Elizabeth II marks the end of an era. It is a time of great sadness for the Royal Family, the country and the Commonwealth alike. It is a time to remember a life of service to her country; very few continue to work at the age of 96 and yet she continued to attend to her official duties appointing her fifteenth Prime Minister this Tuesday. Whilst in mourning, we can also celebrate a life well lived and remember her as an example to us all. His Majesty King Charles III starts his reign with many difficulties at home and around the world, his mother’s example will no doubt be an inspiration.
Following her appointment on Tuesday, Liz Truss has acted swiftly to address the energy crisis. Her plan to cap energy costs at an average of £2,500 per household for the next two years, combined with Rishi Sunak’s £400 support package, will go a way towards easing the worst pressures on households this winter. Furthermore, she announced a cap on energy prices for businesses for the next six months providing some much-needed support. The final cost of these measures will depend on the wholesale energy prices over the next two years, but may be between £100 and £200 billion, substantially more than the £70 billion furlough scheme. She has rejected the suggestion of a windfall tax; hence these measures are expected to be funded from additional borrowing.
The Office of National Statistics (ONS) said last week that when calculating inflation, the £400 subsidy would not be taken into account. It would be treated as an income item and thus have no impact on the price indexes. This latest price cap should impact inflation, meaning that the peak is likely to be closer to 10% than the 13.3% predicted in the latest Bank of England (BoE) report, or the more dramatic predictions from other forecasters. This will be important in reducing some government costs. Index-linked Gilts are linked to the Retail Price Index, so lower inflation reduces the cost of servicing this debt in the short term. If they stick to the triple lock, this means that the state pension may not rise as much next year. Unions seeking inflation-linked pay rises may lower their claims as a result. However, if energy prices remain high, then this is deferring the price rise rather than curing it. The Government will have two years to improve our energy supply and the hope will be that Russian supplies could return to the market before then. The business package is for just six months, and if costs are not to be passed on, then this will need to be extended in the new year.
The cost of this package is substantial and yet the new Prime Minister is also promising tax cuts to boost the economy. This expected rise in borrowing may be passing on the cost of supporting the economy now onto future generations. The hope will be that by boosting the economy, we will increase the total tax revenue to fund it. Under President Regan, the US increased spending and cut tax rates, but saw an increase in the total tax take. The employment market remains tight and wage pressures will rise unless we ease immigration rules or productivity is improved.
With inflation still in double digits, and more price rises en route, the BoE will continue to raise interest rates. We have yet to see the tax cuts, but if there is a substantial fiscal stimulus, then despite the reduction in peak inflation, the BoE may still have to raise rates more and hold them high for longer. The fall in the pound relative to the dollar means that we have benefited less from the recent falls in oil prices. With interest rates rising elsewhere, without at least similar rises from the BoE, the pound may come under further pressure. The rise in borrowing increases the supply of gilts, pushing longer dated interest rates higher.
This is likely to be the first move of a new Prime Minister with big plans. Capping energy costs for two years comes at a cost but defers the impact until after the likely date of the next general election. It gives the government breathing space to sort our energy supplies. They have removed the ban on fracking which may be less popular in some rural constituencies. Building more solar and wind farms must be a priority if the environmental targets are not to be missed. If energy prices had risen as much as expected, then public support for Ukraine and sanctions on Russia could have faded. The new Prime Minister is making a big gamble and will have to do much more if we are to come through with a thriving economy.
As we enter a new Carolean age, the UK in particular, face challenges on many fronts. The new Prime Minister has made a bold start but much more will be needed.
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