GBP 100bn energy support package
Updated: Sep 7
Newly minted Prime Minister, Liz Truss, has indicated that support around the unfolding energy crisis will be revealed shortly – perhaps as early as Thursday. To be sure, more fiscal support is likely, especially with energy bills now projected to soar to over GBP 6,000 by spring next year.
In this very short blog, we set out what our base case for an energy support package would look like for businesses and households, including what direct support the government will likely take to tackle skyrocketing energy bills. In short, we expect spending pledges from PM Truss to total near GBP 100bn (gross). About a fifth to a quarter of spending, we think, will ultimately be paid for by cuts in departmental/ capital spending over the coming years, with the vast majority of spending announcements adding to borrowing (and therefore issuance) in 2022/23 and 2023/24. Increased fiscal support should add to aggregate demand in the medium term, increasing inflation and ultimately increasing the amount of tightening needed for the Bank of England to get inflation sustainably back to target.
Support measures for businesses We expect measures for businesses to revolve around four elements.
First, a freeze in the corporation tax hike. As widely touted, PM Truss will likely fullfil her pledge to keep corporation taxes steady into the next fiscal year. This should cost close to GBP 15bn.
Second, a business loans support scheme. Similar to the pandemic, we expect the government to reintroduce a guaranteed loan scheme for small and medium sized businesses to help with rising energy costs. This would be similar to schemes such as the Recovery Loan Scheme or the Bounce Back Loan Scheme. The cost of such a scheme would depend on take-up, but with Covid loan defaults tracking at roughly 4%, we would expect such a scheme to add only marginally to borrowing (< GBP 1bn).
Third, business rate reduction for small businesses. Recent reports have highlighted that the Truss team could raise business rates relief for premises with a rateable value of £15,000 to those valued at £25,000, meaning many thousands more companies would be spared from business rates. This would benefit a number of vulnerable industries, particularly retail, hospitality, and leisure. The total cost of such a scheme would run to roughly a couple of billion pounds.
Fourth, a VAT cut. There has been a significant amount of noise on the scale and type of VAT cut we could get over the coming weeks. While there is enormous uncertainty here, our base case is that the government opts not to go down the 'nuclear' route option of a 5pp VAT cut as recently reported. Instead, we see the Government opting for a smaller scale VAT cut aimed directly at hospitality and leisure, for 1 year, to 5% – the cost of which would total around GBP 2.5bn. Risks are skewed to a bigger VAT cut, however, with a Truss government potentially pushing for a 5pp VAT cut across the board, costing a much more significant GBP 40bn. It's a close call, but ultimately, we see the next Chancellor opting for a smaller VAT cut, given mounting fiscal pressures.
Support measures for households We see household support focused on five elements.
First, the national insurance reversal. Truss' campaign was centered on a low tax regime. And as a first port of call, Truss vowed to reverse the NICs hike, pushed through by the previous Conservative government. The reversal would cost the new government roughly GBP 18bn per annum, boosting household income meaningfully from winter.
Second, a more generous universal credit package. Targeted support to help vulnerable households through the energy price shock will be of paramount importance. To support the most vulnerable households, we think the Government will extend its universal credit payments to four additional GBP 325 payments (January, April, July, October) in 2023. This should largely cover the Oct-22 increase in energy bills for the most vulnerable households through 2023, at a total cost of GBP 10.4bn, supporting close to 8m low-income households.
Third, truncating the energy bill rebate from six months to three months. This would effectively double the energy bill rebate from near GBP 67 per month to GBP 134 per month, giving households even more direct support to cushion the big energy spike coming in October until an energy bill freeze can be put in place. If the energy bill rebate is not truncated, it's possible that PM Truss could instead opt for cuts to the Ofgem Price Cap (via a suspension of green energy costs and/or VAT at GBP 4bn - GBP 8bn per annum)
Fourth, suspending the green levy within the Ofgem Price Cap. PM Truss has previously outlined that she would look at temporarily cutting green levy costs that households pay as part of their energy bills. A one year suspension of green levy costs would amount to a near GBP 4bn.
Fifth, an energy bill freeze coming in January. As we recently set out, we think risks are skewed to an energy bill freeze coming in January rather than imminently. This would keep energy bills at GBP 3,549 for one year at least, at a total cost of GBP 50bn. There is a material risk that an energy bill freeze starts earlier and perhaps at a lower cap level. Recent reports also suggest that the government may look to slim down an energy bill freeze to only 'vulnerable' households. Ultimately, however, depending on how such a scheme is deployed, its impact on inflation and household incomes could be necessary to avoid amplifying second round effects to prices linked to headline inflation (including inflation expectations).
Close to GBP 100bn in fiscal support to tackle the energy crisis
All up, despite considerable uncertainty surrounding the fiscal outlook, we see close to GBP 100bn in gross spending being announced in the coming weeks – about a quarter of what was spent to tackle the Covid pandemic. And to be sure, risks are tilted to more – not less – spending, given the current trajectory of wholesale gas prices (potentially requiring an extension of support measures into 2024), pushing our total estimate closer to GBP 125bn.
While we see much of this coming from higher borrowing, we think around 20% to 25% of the spending will come from lower spending over the coming years. Indeed, as we noted before, efficiency cuts plus a trim in the public sector workforce alone could end up saving the government GBP 15-20bn per annum (with PM Truss potentially reopening the Spending Review set out a couple of years ago to drive through department spending cuts).
Tax levies on energy profits should also help lower borrowing requirements – albeit marginally (though PM Truss has been sceptical of using any windfall tax to fund spending measures). Altogether, the rise in borrowing should add to fiscal funding pressures, particularly at a time when the Bank of England is planning on selling gilts commencing from late September.
What does this mean for growth and monetary policy? On growth, government policy should help avert a protracted household-led recession, as pencilled in by the MPC – though a mild recession ultimately remains inevitable, given record low consumer confidence levels and plummeting business sentiment. More fiscal spending should also raise inflation in the medium term, though VAT cuts and an energy bill freeze should both dampen near-term inflation.
Medium-term inflation will likely end up a little higher as the VAT cut reverses and households begin to pay for the costs of a potential energy bill freeze. Income support should also push up aggregate demand over the coming years, relative to our previous baseline – pushing up inflation modestly two to three years' out. Altogether, the better growth and stronger medium-term inflation outlook should leave the door open for more hikes, and a more forceful front-loaded hiking cycle from the Bank of England. We will be updating our monetary policy outlook shortly.
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