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Energy bills plan will rein in soaring inflation, but come at a ‘massive’ cost

·3-min read

The Prime Minister’s plan to freeze energy bills will rein in rampant rises in inflation and is set to cut the risk of a deep recession, but experts warn it will carry a “massive” cost to the nation’s finances.

Ms Truss said the move to cap energy bills at £2,500 will slash around four to five percentage points off inflation, meaning it will peak at far lower levels than previously feared.

Martin Beck, chief economic adviser to the EY ITEM Club, is forecasting that inflation will now peak at around 11% in October – still painfully high and the worst for more than 40 years, but less than the 15% he was forecasting before government intervention.

The Bank of England had forecasted inflation of 13.3% in October.

Some economists had predicted that the Consumer Prices Index (CPI) would soar to 22% in January without any support on bills, given that the energy price cap was expected to rise to more than £5,000 at the start of the year, when the Ofgem price cap was due for its next quarterly review.

Mr Beck said the support package “should significantly reduce the risk of the economy falling into recession”, although other experts have said an economic contraction is still likely, albeit less severe.

It is also not thought enough to prevent the Bank of England from raising interest rates once again next week, amid concerns that the measures will stoke inflation in the longer term, with wider costs rising more widely in the economy, in particular as workers demand higher wages.

Policymakers at the Bank are still seen voting for a half a percentage point rise on September 15, from 1.75% to 2.25%, while a bigger rise – to 2.5% – cannot be ruled out, according to some and more hikes may also still be on the way later in the year.

Though it is hoped interest rates may peak at a lower level thanks to the government support.

Mr Beck warned it will also carry a “likely massive, but justifiable, cost” to the public purse, and “leaves the public finances exposed to the vagaries of wholesale gas prices”.

The Government has given no details yet on the cost to the public finances, which will come in Chancellor Kwasi Kwarteng’s fiscal statement later this month, although it is estimated to cost in the region of £150 billion.

Mr Beck said: “Undoubtedly, the new support package entails a massive fiscal cost and exposes the public sector balance sheet to a liability the size of which is unknowable at present – the cost may prove even bigger than expected, if wholesale gas prices rise further, or the winter proves unseasonably cold.

“But there would have been a significant fiscal cost to doing nothing.

“Were households to have been exposed to energy bills in the £5,000 plus range, the consequence may well have been a collapse in discretionary spending and a severe downturn in the economy, with all the fiscal costs of rising unemployment and falling tax revenues that would have implied.

“Moreover, by keeping inflation lower than otherwise, there will be some gains to the public finances in the form of lower interest payments on index-linked debt and a smaller uprating of social security benefits.

“And were gas prices to unexpectedly fall back, the cost of the cap will decline.”