The UK government has announced its energy price guarantee proposal, which will ensure that an average home will pay no more than £2,500 yearly for two years starting on October 1, 2022, in response to a sharp increase in energy prices for homes and businesses this year.
Energy expenses for businesses are guaranteed for six months starting on the same day. After that, the government claims it will focus more assistance on “sensitive areas” like hospitality, but it has not yet given any additional information. To learn more about this proposal and how it will affect inflation, read this article.
What impact will the new strategy have on the UK’s energy crisis?
Although Ofgem’s prior price cap of £3,549 has been replaced by this new strategy, it is vital to keep in mind that these are just two examples.
The amount you pay for your supplier to upkeep the wires and assign an individual to read your meter, among many other things, will be frozen by the government, along with the price per unit consumed and the standing charge.
As a result, there is no ultimate cap on the amount that a customer can be billed; instead, your bill will be based on your usage.
Therefore, any possible savings from the £2,500 guarantee—the government claims that a typical consumer would save at least £1,000 per year—are speculative and will rely on how much energy is used by each household as well as business.
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Does the government’s strategic aim to reduce inflation?
The government strives to minimize inflation by up to 5 percent by easing the impact of high gas prices. At 9.9% right now, inflation is on pace to reach a 40-year high. Inflation in 2021 as a whole was 1.5%, roughly speaking, due to energy.
Because so much gas-fired electricity generation is utilized in the UK, the Russian invasion of Ukraine relatively early this year increased gas costs by 95.7%, which then drove up electricity prices by 54%. Due to this, in April 2022, energy’s share of the inflation rate rose to 1.9%.
Based on the Institute for Public Policy Research, the government could have cut inflation by 3.9percentage points if it had stabilized energy prices considering the average household bill of £1,971 at the time.
However, because of a prior £400 rebate, the new plan will result in an initial 7% rise in energy expenses for the average household from present levels, accompanied by a 27% jump in the following year.
It is challenging to determine the precise impact of the government’s approach without accurate data, especially given the other elements at play. Shocks like the pandemic-related supply chain disruption have an impact on inflation as well.
These problems, along with Russia’s invasion of Ukraine as well as the impact it had on the supply of several commodities, led to demand-pull inflation in the UK. When supply is unable to keep up with rising demand, prices rise. Any one of these variables could change, which would impact inflation rates.
The strategy may also have an indirect impact on inflation. An analogous assurance has been made available to businesses. In light of this, we can estimate that they might still experience an average price increase over the ensuing six months, accompanied by additional uncertainty in the years to come.
Some will increase the cost of goods and services to pass on rising energy expenses to customers. Cost-push inflation, where costs skyrocket as a result of rising labor and material costs, will come from this. Businesses that don’t pass on rising energy costs risk going out of business.
Why will it take so long for any effects to be seen in the inflation rate?
By establishing a median energy price, the strategy may have an immediate effect on people’s budgets. However, as consumers, as well as businesses, modify their investment and consumption in reaction to the policy, the effects would not be felt in a price increase for some time. In around 1/3, the monthly inflation forecasts from the government might start to bear fruit.
Who will finance the strategy?
According to Liz Truss, to finance its strategy for the energy issue, the administration will borrow the money. The sale of gilts and bills, which are loans to the seller in this situation the government, to investors such as pension funds as well as insurers, accounts for 85% of all government borrowing at the moment.
As a result of repaying these loans, taxes will have to be increased, thereby forcing present generations to pay for the spending of today. The Institute for Fiscal Studies estimates that each additional £1 that families spend on energy will likely cost the public 75p over the next year.
Some contend that the expense should be covered by taxes on energy companies. Within the next 2 years, price increases are anticipated to increase these corporations’ earnings by £170 billion.
As an alternative, modifying the unit price cap depending on multiple levels of use as opposed to using a general cap based merely on average usage would make high energy consumers pay more for each unit and might even induce a decrease in consumption.
Will the extra borrowing have an impact on inflation?
By borrowing a projected £100 billion in the first year and investing it into the power sector, the program will undoubtedly boost the amount of money available in the UK. It will be a fiscally expansionary strategy, which is advantageous for development but might lead to higher demand-pull inflation.
The Bank of England will probably keep raising interest rates to curb inflation at the same time. Everyone’s borrowing costs will increase when interest rates rise, as well as the government.
There are already several loans outstanding for the government. At $2,365.4 billion, or 99.6percent of GDP, its gross debt is the highest it has ever been. Additional unexpected borrowing will increase pressure because it will drive up borrowing costs even further, given the present inflation rate.
To conclude, according to economists, it is said that the administration is given some room to breathe by the energy crisis strategy; however, it is said to only be a general fix.
It is believed that the outcome might have been improved with a more focused strategy. To add, you must know that to resolve the actual cost of living crisis, far more daring as well as challenging decision-making will be required.