The Return of Stagflation: How The Cost-of-Living Crisis is Preparing a Vulnerable UK Economy to Face its Coldest Winter on Record. Could Nationalisation Offer the Warmest Blanket of Support ?
[Citibank forecasts CPI to breach 18.8% in the first quarter of the 2023 as UK energy prices continue to surge. Photograph: Telegraph, 2022]
On the 24th of February 2022, Russian premier Vladimir Putin sat down in front of the international stage and announced that the nation would begin conducting special military operations in the sovereign nation of Ukraine. Sitting directly in front of the Russian flag, his mission was disguised in simplicity; to demilitarise his southernmost neighbour and protect Russian backed separatists in the Donbas region from a regime of nazification and genocide instigated by the Ukrainian government. Such news sent shockwaves across the globe, echoing the not so distant past to a time when Europe had found itself in the midst of another continental tragedy on the cusp of the 21st century. Since the announcement in February, the UN estimates that as of the 30th of August 2022, more than 7 million refugees have fled Ukraine across Europe. Each civilian displaced in itself is a tragedy, every life lost to this perverse war represents a family, lost and afraid, uncertain as to what the future brings to them in such a time of bleak uncertainty; that is something that cannot be denied. However, on an international scale, the impacts are just as lamentable. Since the invasion, Ukrainian Economy Minister Yulia Svyrydenko has forecasted that the economy is to contract by 35-40% by the end of 2022, with the implications of this downturn being felt in various financial channels such as world commodity prices at all time highs and the adverse implications that this has on investor confidence in Europe and around the globe. Natural gas, coal and oil have been the main recipients of the supply chain price disruptions caused by the war, leading to a year to date surge in August 2022 of 121.57%, 141.64% and 38.3% respectively. This has sent a tidal wave of inflationary implications across Europe, hitting an already weakened UK economy which has seen prices rise significantly during the aftermath of the Covid-19 pandemic.
[More than 12 million Ukrainian refugees have fled since the Russian invasion in February. Photograph: Emilio Morenatti/AP]
With the price of fossil fuels being at an all time high, the UK economy looks in an incredibly vulnerable position in the face of an already looming recession. As of the August 2022 Office of National Statistics (ONS) report, it is estimated that CPIH, the most comprehensive measure of inflation, is to skyrocket to over 8.8% in the 12 months up to July 2022. Analysis of the hike indicts housing services, transport and food prices as the main contributors to the upward cost pressures, with such a rapid rise holding rather bleak historical relevance; the July 2022 figures are the highest recorded annual inflation rate in the National Statistic series, which began in January 2006. On an even more meagre note, Citibank forecasts CPI to breach 18.8% in the first quarter of the 2023, far surpassing the Bank of England’s forecast which expects consumer price inflation to hit a more modest, nonetheless excessive, rate of 13% by the end of the year. A figure as excessive as 18% has not been recorded since the days of Callaghan’s labour 1976 government which required an emergency bailout by the IMF to the tune of $3.9 billion. Lying at the bedrock of the fragile prices of housing, transport and food prices, is the UK’s reliance on imported European energy, which, as a result of political turmoil in Ukraine, have put immense upward cost pressure on these CPI basket items as firms try to recuperate sinking profit margins. On the foreign exchange market, the value of the sterling against the dollar stands at around 1.17 as of August 2022 but is forecasted to weaken to the tune of 1.12 in one year's time as the inflationary pressures eat away at real deposits, ushering investors to reallocate capital elsewhere. The projected hikes in interest rate also begin to ring the alarm bells to foreign currency investors that economic growth is beginning to be discouraged alongside reductions in consumer spending. It is therefore very likely for the pound to continue to depreciate against the dollar, pulling capital flows out of London. Short positions have begun to mount against the pound as the supply chain disruptions caused by Russia have furthered UK inflation, with Bank of America stating that the sterling faces the threat of becoming an ‘emerging market currency’ due to its slow growth and continued volatility. Such a weakened sterling further adds to the upward inflationary pressure as imports become more expensive to both businesses and consumers, further extenuating the domestic price rises.
The effect this imposes on UK households and firms has the potential to be catastrophic. Households in the lower income bracket are most likely to be most exposed, as such a group tend to spend a higher proportion of income on energy expenditure, rent and essential food items. Consumers are likely to cut back on spending for non-essentials in order to offset uncertainty over prices in the future, which could lead to businesses laying off a percentage of their workforce in order to save costs. For those employed, wage growth has fallen short of inflation. The Bank of England forecasts that private sector settlements to average 5.8% which fails exceed the expected levels of inflation for the next fiscal year; income growth is therefore expected to fall in real terms, with many households thrown into situations where wages will not be able to cover the increasing costs of essential items. It has therefore been speculated that a period of stagflation is to return to the UK economy; a situation of high inflation rates complemented by low levels of economic growth, a scenario which the economy has not seen the likes of since the 1970s.
[The UK economy is set to enter a recession expected to last until 2024 as inflation soars above 18%. Photograph: In Pictures Ltd./Corbis via Getty Images]
In reaction to the soaring levels of inflation eating away at real wages, the UK economy faces yet another integral threat; the industrial action of many key sectors which have the potential to undermine the foundations of the highly interdependent British economy. Strike action following wage depletions are most likely to hit the public sector, which ONS estimate, since the 2008 financial crash, have fallen by 4.3% in real terms; a figure which is expected to continue to rise indefinitely due to the current cost of living crisis unless strong trade union renegotiation takes place. Teachers, doctors, nurses, post, port and refuse workers are expected to see their incomes fall below inflation during the year 2022, with all key industries expected to take strike action between August and September 2022. Such industrial action gives those wise enough to remember the bitter nights of 1978 more than a chill. Such a fateful year saw purchasing power decrease by 8.3%, causing a restless general council, who, to the dismay of Callaghan's Labour government, refused to settle for the meagre 5% wage offering. The result was the largest stoppage of labour since the general strikes of 1926, leading Callaghan out of Downing Street with his tail between legs, only to be succeeded by the Thatcherite government which sent the UK economy on a completely new trajectory of deregulation, tax cuts and most starkly the cessation of trade union power.
To try and offset such an inflationary spiral, the Bank of England is expected to raise its interest rates in September 2022 by 0.5 percentage points, from 1.75 to 2.25, making it the 7th successive rate hike by the Central Bank and its largest rate increase in over 27 years. This is intended to protect consumers from the threat of cost push inflation but poses a threat, both to consumers and firms in the credit market, as the cost of borrowing is pushed even higher. Those on fixed term mortgage contracts are likely to see their housing bill increase on average by £200 a month as the 2-year fixed rate climbs above 4%. Such rate hikes pose threat to businesses also, with the increased interest rates reducing the financial capacity of many firms, leading to a slowing of investment alongside a rather dismal state of European business sentiment following the Russian invasion of Ukraine.
[Echoes of the 1978 Winter of Discontent as thousands take to the picket lines in protest of sinking real wages. Photograph: Mirrorpix]
As of the 31st of August 2022, 10 Downing Street remains vacant following former PM Boris Johnson’s early resignation on the 7th of July. Since then, the battle within the Conservative party has continued to brew, with leadership candidates Rishi Sunak and Liz Truss leading fierce debate as to how to manage the looming threat of recession posed by the energy crisis. It is clear to see that the next leader to take office must offer the best resolution to this ongoing crisis, yet neither side has committed to a definite plan of action in order to lead the nation out of, what is to become, the most crushing economic catastrophe the UK has faced since 2008.
The first policy suggested by practitioners would be to directly help those most vulnerable; those who sit within the lower income bracket, as such a group are most exposed to the energy price hikes, many of whom were already thrust into energy poverty before prices began to rise. Increasing universal credit allowances, by the suggested £20 a week, would therefore be a solution to offering direct welfare assistance to those most exposed to the crisis. A second solution would be via the implementation of a one-off levy in the form of a windfall tax on the excess profits generated by energy suppliers. BP, Chevron, Total, Shell and ExxonMobil generated eye-watering profits, upward of £50 billion, over the last financial quarter and according to Reuters' August 2022 analysis, Big Oil could generate up to £170 billion over the next two years at the expense of British households; 54% of which are going to be thrust into fuel poverty by October 2022. British Petroleum even went as far as to say that they have ’more cash than (they) know what to do with’ whilst the rise in fuel bills continues to soar beyond 80%, with experts expecting a 200% increase by January 2023. Extending such a levy would generate an additional £5 billion according to Treasury correspondents, which would facilitate the financing of a £37 billion support package to UK households “which includes direct payments worth at least £1,200 each to the 8m most vulnerable families, a record fuel duty cut, and a national insurance cut worth up to £330 a year for the typical employee” (Sky, 2022). Truss, alongside Johnson, believe that the increased tax on profits would have a negative impact on business confidence, making the UK an even more unpredictable place to invest. Ex-premier Johnson states concern for the levy, stating that excess profits should be allowed to be generated as they provide valuable financial artillery in order to invest into more green, renewable energy sources, although environmental groups suggest that the levy’s tax receipts should instead be ‘invested in(to) energy-saving measures such as insulation for homes in a move that would help to address the climate crisis as well as reducing dependence on despotic oil- and gas-producing regimes such as Russia’ (Guardian, 2022).
[BP shareholders rejoice as monthly profits surge to £7 billion amidst the ongoing war in Ukraine. Photograph: AAP: Dan Peled]
Alongside the suggested raises in universal credit and tax levies on big oil, there exists another policy solution, of which, has remained a dormant structural tool since the 1990s; the (re)nationalisation of the big-five energy companies in the UK, a policy suggestion which has been at the cornerstone of Labour's manifesto until Keir Starmer revealed plans to axe the project in July 2022. Nonetheless, a Survation poll found that 66% of the public want to see the energy sector return to national ownership, with nearly half of Conservative voters in support of the measure. Such a policy suggestion is also beginning to develop momentum through thorough backing and pressure by the Green Party. The plan would see the implementation of a price cap, returning the amount households have to pay to levels of Autumn 2021, protecting the most vulnerable in society who lack the capacity to pay the inflated prices over the winter period. Implementing the measure over winter would cost the government an estimated £37 billion which would be financed via the windfall tax placed on Big 5 company profits, with such an approach remaining fiscally neutral as the state gains a revenue-generating asset. Appeals for a far-left approach have not been seriously considered since before the days of Thatcher, but as annual fuel bills soar beyond 80%, the traditional orthodoxy is beginning to be gravely reconsidered.
Not everyone is fully convinced, however. The UK is still not a main player in its energy production, relying on external sources, like Russia and Norway, to import its fuel. Due to this lack of self-sufficiency in the energy market, the nation would still have to pay the higher prices for foreign energy even if it did manage to subsidise consumer electricity bills in the short term; the burden is simply lifted from the individual to the taxpayer in the long-term. The introduction of price controls below that of the market price is therefore likely to lead to surplus demand, or in other terminology, a shortage of consumable energy, as the artificially lower prices disincentivise additional UK energy production leading to a potential scenario over winter where certain households fail to receive any electricity at all; such a price cap carrying the potential to invoke the law of inverse consequences, a situation that government will be trying desperately to avoid during their policy selection. Some economists are also clear in saying that the higher energy prices are a simple reflection of the shortage of supply imposed by the supply-chain disruptions caused by the ongoing war in Ukraine, with the price cap likely to disrupt the the free market price signals and discourage further energy production.
[A YouGov survey found that 47% of Conservative voters are in support of the nationalisation of the energy sector; a plan which would cost the UK government an estimated £37 billion. Photograph: WiganToday]
With all these potential policy measures thrown around in media discussion, all households and firms can do in the meantime is wait, patiently. Wait until news of Johnson's successor is announced to the nation, with their policy plans following shortly after. Plans which could see either see the redemption of the UK economy or its further condemnation over the winter period and into 2023. As the frozen soul of a wounded Ukrainian economy begins to drift across Europe from the East, the UK begins its insurmountable task of protecting those most vulnerable from the wrath of exponential fuel bills- failure to do so could see British living standards fall to levels not seen since the 1950s. Winter may not have arrived in the UK just yet, but unless the next Prime Minister manages to provide a blanket of warmth and adequate guidance for the near future, the economy could be heading for a winter more inhospitable than that of 1978.
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