Energy price cap to limit inflation: Pound rallies as Truss plans £140bn support package
Plans by Liz Truss to cap energy bills could mean inflation has already peaked, economists said last night.
When Britain’s third female prime minister took office, City pundits suggested the pressure on family finances may be easing.
Inflation hit 10.1 percent in July – the highest level in 40 years – and economists have spent much of the summer warning that far worse was to come.
Taking the helm: New Prime Minister Liz Truss and Governor Andrew Bailey in front of the Central Bank
Analysts at Citi said last month inflation could hit 18 percent, while Goldman Sachs warned it could rise to 22 percent.
But in a dramatic change of tone, as reports of Truss’ $140 billion energy rescue
The intervention – including around £100bn in support for households and £40bn for businesses – should also dampen recession fears.
And it could ease the pressure on the Bank of England and its beleaguered Governor Andrew Bailey as they hike interest rates to bring prices back under control.
Elizabeth Martins, Senior Economist at HSBC, said Truss’ price cap could prove to be a “game changer”, adding: “It would be expensive, but if it were to freeze the cap at current levels it could even mean that the Inflation has already peaked. ‘
This contrasts with recent predictions that inflation could even top 20 percent as wholesale gas prices soar as Russian President Vladimir Putin chokes off gas supplies to Europe.
Markets were optimistic on the cost-of-living package. The battered pound, which has traded at nearly two-and-a-half year lows, climbed above $1.16 against the dollar in early trade before retreating.
Borrowing costs are rising
The government’s borrowing costs soared yesterday as investors fretted over the impact of Liz Truss’ plans on the nation’s creaky finances.
The yield on 10-year gilts — the interest the government pays on debt packages it issues to raise cash for expenses it can’t fund through taxes — rose to as much as 3.147 percent.
That was the highest level since 2011.
This effectively means that investors are demanding higher interest rates to lend to the UK.
Yields on 30-year debt rose to 3.374 percent in March 2020, the largest one-day jump since the pandemic began.
Sanjay Raja, senior economist at Deutsche Bank, said it expects the “vast majority” of the new package to be paid for through borrowing.
In the stock market, Greggs, Wetherspoons and B&Q owner Kingfisher were among the gainers as investors bet they would benefit from an easing of fiscal conditions.
Rising inflation has prompted the Bank of England to embark on a path of successive rate hikes – most recently a half a percentage point hike last month and some calling for an outsized 0.75 point hike when officials meet next week meeting.
Catherine Mann, a member of the bank’s rate-setting committee, called for “swift and forceful” action this week.
However, HSBC’s Martins said the new energy policy would “potentially reduce inflation expectations and the likelihood of a wage-price spiral – the two main reasons why the bank decided to take a tough stance in August”.
Fabrice Montagne, Barclays’ UK chief economist, also said inflation may have already peaked and could have fallen to 5 percent by April next year, rather than the previously forecast level of more than 11 percent.
“By capping energy prices, the government would be a very welcome help to the Bank of England in regaining control of inflation dynamics,” Montagne said.
Holger Schmieding from Berenberg said: ‘If households can spend more money on non-energy goods and services, the recession in Great Britain could also be a bit shallower than we are currently forecasting.’
Capital Economics’ Neil Shearing said the price freeze could buy the government time to shake up the energy market – describing the policy as “an expensive band-aid but not a long-term solution”.