By Scott Simmonds, researcher
When the Treasury Committee met last week to discuss the Bank of England’s Financial Stability Report, the Governor of the Bank of England, Andrew Bailey, highlighted two areas that he considers are contributing to the current cost of living crisis; energy prices, and global supply chains.
Mr Bailey claimed these pressures “ought to be” transitory. As Russia supplies almost half of Europe’s natural gas, the current situation in Ukraine looks to continue the pressure on commodity prices. Mr Bailey commented “if we are going to have a more elevated gas price, that is a source of concern. I have to be honest.” Global supply chains, the other area of concern raised, are still straining to return to normal levels after the pandemic brought the global economy to a standstill. The knock on effect is higher prices on everything, from everyday essentials to building supplies.
With inflation now at 5.4 per cent – the highest rate in 30 years – we could be witnessing the consequence of high levels of borrowing. Last year alone the government borrowed £303 billion, or 14.5 per cent of GDP - a peacetime record. Should we really be surprised that inflation is set to reach 6 per cent by spring?
ONS data released today reveals the impact inflation is having on central government interest payments. December’s interest payment was £8.1 billion, an increase of £5.4 billion in a single year - a 200 per cent increase. This is the same amount the government committed in the Spending Review to local road upgrades and maintenance over this entire parliament. Not controlling inflation is hurting hard-working taxpayers who'll ultimately have to pay for the government's inability to get a grip on the issue.
But it’s not just government borrowing that we should be concerned about. Elisabeth Stheeman, external member of the Financial Policy Committee, raised the issue of SME debt levels, which rose by 25 per cent during the pandemic. Many have never borrowed anywhere near this level of money previously, suggesting the reliance on cheap borrowing may be spreading throughout the economy.
Fortunately, interest rates are not forecast to rise quickly. Mr Bailey commented that the structural forces keeping interest rates low - an ageing population, low productivity, and the balance of savings and the demand for investment - don’t look like changing any time soon. Although as Mr Bailey warned, “that’s not to say that interest rates won’t rise, it’s to put it into context how much.”
These factors may be holding interest rates down, but they are also impeding growth too. When coupled with the national insurance hike that comes into force in April, on top of what is already the highest sustained tax burden in 70 years, our growth forecasts look rather cloudy.
Given the UK’s current financial position, surely the government is looking to limit spending and cut taxes? In fact, the opposite is happening. According to the latest figures, the public sector has actually grown by 232,000 employees since the start of the pandemic. A bloated public sector and high levels of spending lead to evermore tax rises. With the country emerging from covid, now is the time for ministers to cut taxes and instead ‘Save to Spend’ - keeping the government’s spending promises by finding savings elsewhere. We suggested 15 simple policy changes that would save £73 billion by 2025-26.
Milton Friedman once said: “Inflation is a tax, which is imposed without representation, and which nobody has to vote for.” This ‘tax’ we are seeing now is the result of choices the government has made, and continues to make, which we are all paying the price for.