Sunday, January 16, 2022
The big squeeze is on - and Sunak's tax hikes add to it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Inflation is all around us. While this week’s UK figures may only show the annual consumer price inflation rate treading water at around 5 per cent, America has shown where it is heading this spring. Its latest 7 per cent rate the highest since 1982.

Britain has a more chequered inflation history than America, and if the rate gets to 7 per cent as energy and other price increases come through, it will merely be the highest rate since 1992. But that was five years before the Bank of England was given the task of meeting an inflation target, now 2 per cent, “at all times”. That will not happen for quite some time.

Part of the reason for high inflation is the effect of switching the economy off and on again. Figures on Friday, showing a 0.9 per cent rise in gross domestic product in November, and the economy regaining the pre-pandemic levels of output of early 2020, confirmed the unusual nature of this cycle. Normally it takes three years to get back to where we were and after the financial crisis it took five. Even if Omicron now causes some slippage, this was a rapid rebound.

It will be painful news for some that Greggs, the bakery chain, intends to raise prices by 5p or 10p across a range of items. Food prices more generally are rising strongly. Next, meanwhile, says its spring and summer ranges will rise in price by an average of 3.7 per cent, while prices for autumn and winter products will go up by 6 per cent compared with 2021. Clothing prices have been a drag on inflation for many years but, it seems, no longer.

Chris O’Shea, the chief executive of Centrica, which owns British Gas, giving a BBC interview while dressed as if about to go out and service a boiler, warned that high energy prices were likely to last for the next two years, and called on the government to scrap VAT on energy bills and move environmental levies off bills and into general taxation.

One interesting question is what car manufacturers will do when chip shortages ease and new cars become more generally available. They have seen used car prices rise rapidly – up by 31 per cent between April and November last year – and might be tempted to revisit their new car price lists when supplies come back on stream. Some second-hand vehicles are selling for more than the list prices of new ones.

A useful set of projections from economists at BNP Paribas shows that, while inflation in the eurozone should be back below 2 per cent in a year’s time, it will take longer in the UK. The Bank will release new forecasts on February 3, when it is also expected to raise the official interest rate from 0.25 to 0.5 per cent. Its last forecast, In November, merely promised that inflation will be “close to our target in around two years’ time”.

Inflation has been cropping up in unusual places. Germany, normally regarded as the anti-inflation bellwether, saw inflation hit 6 per cent, on a comparable basis, late last year, higher than the UK’s 5.1 per cent, though some of that reflected the unwinding of a temporary VAT cut, which the German government instituted in the second half of 2020, as part of its pandemic response.

It looks on the face of it as if the “Anglo Saxon” inflation problem will last longer than the eurozone’s. That would fit in with the warnings of monetarist economists like Tim Congdon, who warned of the inflationary consequences of huge quantitative easing (QE), for both America and Britain, but also others, like Larry Summers, who warned that Joe Biden’s huge post-pandemic economic stimulus would be inflationary.

It also fits with the responses of central banks. The Bank of England, which announced an unprecedented December interest rate rise last month (unprecedented in the independence era), even in the face of fears about the economic impact of the Omicron variant, has become noticeably more hawkish, as has America’s Federal Reserve. Some say that the European Central Bank, which has not, is falling “behind the curve”. It is still mainly sticking to the line that most of the inflation rise in temporary, or “transitory”. It will eventually tighten policy but take its time to do so.

The question for the UK is how long-lasting this inflation surge is likely to be and what, if anything, the government should do about it. That there will be a squeeze on incomes is not in doubt. The Institute for Studies points out that, with most working-age benefits set to rise by 3.1 per cent next April, the poorest will see their incomes falling well below the expect inflation rate then, which could be nudging 7 per cent. The same is true of the basic state pension.

Abandoning the “triple lock” for the basic state pension, thus breaking a manifesto commitment, and replacing it with a 3.1 per cent increase, seemed sensible last year, when the alternative could have been to raise it in line with distorted average earnings figures. But 3.1 per cent will condemn pensioners to a fall in the real value of their incomes.

The government is under pressure to do something about that, as it is to scarp VAT on domestic energy bills, if only temporarily. April’s tax hikes, similarly, look to be particularly ill-timed, with National Insurance and income tax both due to rise, the latter via the stealthy route of not indexing allowances and thresholds. That will bite at a time of high inflation. The chancellor is under pressure to postpone or cancel some of these hikes.

I think we can safely assume that, having warned Tory MPs a few days ago about the consequences for the government’s debt interest bill of rising inflation and interest rates, Rishi Sunak will be very reluctant to do any of this.

Shielding benefit recipients and poorer pensioners from the inflation surge would cost a few billion, while scrapping VAT on domestic energy for a year would cost roughly £2 billion. Moving environmental levies into general taxation would add to a tax burden that is already on course to rise to its highest since the Attlee government was in power in the early 1950s.

Delaying the NI and income increases would lift the cost of protective action by the government from the billions into the tens of billions. Those increases are baked into the official projections for the repair job on the public finances that the chancellor has embarked upon.

Sunak is also aware that temporary actions can all too easily take on an air of permanence. He faced a battle over ending the £20 a week temporary uplift to universal credit. If April’s tax increases were postponed would the time be ripe for reimposing them a year later, with an election becoming ever closer? The same goes for VAT on energy bills.

So, while there may be some limited help for people, particularly lower income households, to get them through the inflation squeeze, the chancellor is unlikely to bring out the fiscal bazooka, which he used effectively during the pandemic.

Mostly, we will have to grin and bear it, and hope that the worst of the squeeze is over by the middle of the year. That is what economists expect and there is a good chance that it will happen. Some of the increase in inflation will indeed be temporary. Even gas prices, the main cause of the energy price surge, have fallen, though too late to affect the big increase in the energy price cap due in April.

Figures provided to official statisticians by the National Grid show that the seven-day system average price for gas fell to just over 6p per kWh last week, half their pre-Christmas level. Energy prices are highly volatile, but it would be surprising if the kind of increases we saw last year were to be repeated.