Report warns higher inflation due to the Iran war risks leading to higher government borrowing costs – as it urges ministers to consider £2,000 energy price cap and other measures to lessen the impact
The Iran war could cost the government £8billion this year through higher borrowing costs and less tax, a think tank has warned.
A new report from the Institute for Public Policy Research (IPPR) urges the government to act now to reduce the risk of the Middle East conflict causing long-term damage to the UK economy and public finances.
It comes as UK government long-term borrowing costs hit a 28 year high earlier this week on the back of concerns about the economic fall-out of the war here, as well as political uncertainty around the local elections. The IPPR points out that more than a quarter of UK government debt is linked to the wider rate of inflation, which has risen on the back of soaring oil prices. It warns that, without action, the rate of inflation could jump from the current 3.3% to 5.8%.
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The IPPR says there are measures that the Treasury and Chancellor Rachel Reeves can take to reduce the spike, and avoid the need for damaging interest rate rises. Those include introducing a temporary energy price cap at £2,000 to limit inflation, and a temporary 10p fuel duty cut to offset rising oil prices.
It also recommends reducing speed limits on the road to lower drivers’ fuel consumption. And it backs the idea of “targeted, progressive tax measures”, including strengthened windfall taxes on energy profits.
The IPPR the cost of the package of measures at up to £5billion a year, depending on the severity of the shock. However, it says this could be more than offset by savings on higher debt interest costs and the hit to taxes from an economic go-slow.
William Ellis, senior economist at the IPPR, said: “The UK cannot afford to sit back and let another energy shock drive up inflation and damage the economy. The UK economy and public finances are expected to take a significant hit from the Iran conflict, regardless of whether the government intervenes.
“The Bank of England is not well suited to respond, given the lag that it takes for interest rates take to influence demand. However, as the Bank set out last week, it is still likely to increase interest rates to guard against second round effects and high inflation expectations – particularly if the conflict escalates.
“The government can act now where the Bank can’t, with a well-designed policy that acts to cap prices only in the most damaging scenarios. At worst, this would save about as much as it costs – but if permanent damage or sharp interest rate rises are avoided, this could end up saving money.”
Sam Alvis, associate director at the IPPR, said: “A well-designed intervention, that pairs capping prices with clear incentives to reduce energy demand, would not only protect living standards but prevent the need for damaging interest rate rises, and insure against the risk of more severe damage.
“This is cost-effective, and if permanent damage is avoided, this actually saves the government money. Keeping interest rates lower and investment higher prevents any damage to deploying and using clean energy, the long-term solution to crises like this.
“The lesson from Liz Truss is clear: it’s not intervention that spooks markets, it’s poor policy design and an ignorance of investors’ concerns. With the right approach, the government can act decisively and responsibly at the same time.”
