The UK economy suffered several shocks in 2022. As in other developed countries, the energy crisis led to a slowdown in growth and an acceleration in inflation. This, which was only 2% at the start of 2021, reached 10.1% in July 2022, as a result of the increase in energy prices, and had not decreased in September. A high level, although the price increase then reached 10.9% in Germany and on average in the EU and up to 17% in the Netherlands or more than 20% in the Baltic countries.
It must be said that gas and electricity prices in the UK followed market rates until October 1 last year, when a cap came into effect to limit the rise in household bills. It will now curb inflation but will have a high budget cost, estimated at £31 billion for the period October 2022 to March 2023.
The high level of inflation, while unemployment is low (3.5% compared to 3.8% in the fourth quarter of 2019, before the start of the Covid crisis) and labor market tensions remain strong in various sectors, have contributed to increasing social tensions. Thus, the think tank Resolution Foundation warned at the beginning of September about the risks of increasing poverty, estimating an increase of 11 to 14 million in the number of people living in absolute poverty, of which 30% are children.
Energy prices: UK caps household bills
To these economic difficulties came a political crisis: the resignation of Boris Johnson, followed by the appointment of Liz Truss as Prime Minister on 6 September. On September 23, a very costly plan for growth put the country on the brink of a financial crisis. Based on the trickle-down theory, this program relied on deep tax cuts, concentrated on the wealthiest households and businesses. But it did not allow for corresponding cuts in public expenditure. He broke with the social tone that Boris Johnson wanted to give to his act.
Based on the supply policy, with also deregulation measures and the creation of investment-free zones, the plan counted on induced growth to avoid the increase in public debt. It has been the subject of numerous criticisms from economists (and even the IMF) and has worried the financial markets. Yields on 10-year government bonds rose rapidly, rising from 3.1% to 4.5% between September 19 and 27, prompting the Bank of England to adopt emergency measures to avoid a financial crash, particularly from pension funds. The pound, on the other hand, fell from 1.14 to 1.11 euros in the same period.
Within days, the resignation of Finance Minister Kwasi Kwarteng, his replacement by Jeremy Hunt, the reversal of a large part of the tax cuts, the resignation of Liz Truss and his replacement by Rishi Sunak, a wealthy financier, not very popular with the British, but appreciated by business circles, the announcement of the presentation of a budget on November 17, which maintains the support for households and companies affected by the increase in energy prices as well as the objective of reducing public deficits, calmed the tensions in the financial markets . 10-year yields fell to 3.4% in early November and the pound rose to €1.16.
UK: Inflation accelerates again, at 40-year high
The Bank of England raised its key interest rate by 0.75 points to 3% on November 3, acknowledging that inflation could reach or even exceed 11% by the end of the year before falling “significantly” in the spring. 2023. The new government faces a particularly difficult situation, as growth has probably already been negative in the third quarter: limiting the impact of rising energy prices and interest rates on households and the most fragile companies, committing to a goal of reduce debt and public deficits, while rebuilding a health system damaged by the pandemic and supporting growth. The exercise will be dangerous. The episode at the end of September showed that the financial markets no longer believe in the supply side alone.
*Catherine Mathieu is an economist at OFCE (French Observatory of Economic Conditions).
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