This is Rishi Sunak’s chance to stop a recession; any delay and it will be too late | Larry Elliot
Jthe bank of england a message to Rishi Sunak was simple. Russia’s invasion of Ukraine is the latest unwanted shock to the UK economy. It will make people poorer. We, the Bank, cannot do anything about it. So, over to you, Chancellor.
Threadneedle Street is absolutely right. It does not have the tools to react to rising world commodity prices, but the Treasury does. Sunak has all kinds of ways to ease the pain: cut taxes, increase benefits, reduce excise duties, help pay energy bills.
And while the original intention was not to turn Wednesday’s Spring Statement into a mini-budget, recent events mean that is what it needs to become. Unless Sunak wants to go down in history as the new Philip Snowden – the Labor chancellor who cut benefits during the Great Depression – he’ll have to come up with something meaningful.
Sunak says he is “done” with tax increases and has sympathy for people struggling to make ends meet. He needs to convert words into action because that’s the way things are. Inflationary pressure was building even before Vladimir Putin decided to invade Ukraine, because as the global economy began to emerge from lockdown, the supply of commodities – like oil – struggled to keep pace. demand.
Both businesses and consumers are affected by rising inflation. Businesses that face higher costs for fuel and raw materials have a choice: try to pass the costs on to their customers or squeeze their profit margins.
Consumers face a similar problem. If it’s costing them more to fill up gas or heat their homes, they can either try to get pay raises that keep pace with inflation, reduce spending on non-essentials, or accumulate debts.
It’s not hard to see how things will play out in the months to come. Companies will initially seek to pass on their higher costs to their customers, but will be unable to sustain price increases as consumers tighten their belts.
As any A-level economics student knows, national output – or gross domestic product – is consumer spending plus investment plus government spending plus exports net of imports.
Consumer spending will be weak this year as wages will not keep pace with prices. Companies will mothball their investments as the costs of doing business rise. The chances of an export-led boom are nil given that every other energy-importing country faces exactly the same pressures as the UK.
This leaves the government, where the policy is currently the opposite of what it should be. Sunak froze tax allowances for the rest of parliament; it will increase national insurance contributions for employers and employees by 1.25 percentage points from next month; and he temporarily removed the triple blocking of pensions. Taken together, these measures will suck tens of billions of pounds out of the economy at the wrong time.
The Treasury has a dual function. It is above all a Ministry of Finance to which is added a Ministry of the Economy. During the early stages of the pandemic, the finance ministry element took a rare back seat as there was a clear need to spend money to prevent the economy from collapsing during the lockdown. Now that the pandemic is perceived to be over – although there appears to be a sting in the tail – the Treasury has returned to its normal mode of operation, with government borrowing cuts as its main objective. This mindset needs to change.
It’s not like Sunak hadn’t been warned. The Bank of England was already predicting the greatest strain on living standards since modern records began three decades ago, and says the impact of the invasion of Ukraine will “significantly” worsen the situation.
Analysis of the numbers by chartered accountant and political economist Richard Murphy suggests the loss of standard of living will be extremely painful: a 14% hit for someone on minimum wage, 11% for someone on median income.
“For half of UK households, it’s very hard to see how they stand a chance of making ends meet without significant government support,” Murphy says. “This is not only disastrous for them, it also signals that a recession is very likely unless Sunak acts now. A delay would make it almost impossible to prevent a massive downturn.”
It’s hard to disagree with Murphy’s conclusion. As things stand, Britain is heading into a monster recession and time is running out for evasive action.
It is clear that after fighting and winning a battle with Boris Johnson, Sunak is not going to give up or even postpone increasing NICs, even if pursuing them now is an act of economic self-harm.
But the Chancellor has dropped enough clues in his Sunday morning TV appearances to make it clear he will announce further help this week. The fuel tax seems certain to be reduced and it might be tempting to shoot the Labor fox by announcing a temporary reduction in VAT on household energy bills. Either measure would increase purchasing power and reduce the annual inflation rate.
Sunak announced a package to help households with their energy bills early last month that already seems insufficient. The Treasury, however, is reluctant to make it more generous until it knows what will happen to the energy price cap when it is next revised in October.
That leaves state benefits, which are expected to rise 3.1% next month, about five percentage points below the likely inflation rate. Raising benefits in line with the expected rate of inflation would protect the most vulnerable and stimulate the economy. It would be expensive, but not as expensive as doing nothing.