Energy shocks are the new normal but Britain’s not ready for it

In the Chancellor’s spring forecast speech yesterday, she asserted with confidence that ​“this government has restored economic stability”. Meanwhile, UK gas prices jumped 50% in a day on Monday, bond yields have been rising as investors shift their expectations about inflation and sterling is falling — hardly the hallmarks of a settled and stable economy.

Soaring oil and gas prices triggered by Trump’s ​“Operation Epic Fury” are already reverberating through global markets — and this turbulence may only be beginning. Whether from this conflict, further geopolitical flare-ups, or climate-related disruptions that are growing more frequent, supply shocks are becoming a defining feature of the economic landscape. This latest development cements the reality that, far from coming to the end of an era defined by supply shocks and economic instability, it has only just begun.

The UK economy is highly exposed and markets know it. UK gilt yields in recent days rose more than German Bunds and US Treasuries, indicating a perceived larger inflationary risk for the UK relative to other economies, and expectations that the Bank of England will keep interest rates higher for longer. In turn, high borrowing costs throughout the economy constrain investment, sustaining vulnerability to economic shocks.

The problem is that the UK’s core macroeconomic institutions are undermining the government’s ability to take the action needed to adapt to an increasingly turbulent world. Our current fiscal framework constrains the public investment needed to deliver energy security and limits the government’s ability to shield households from price volatility of essentials like food and energy. Prioritising strict adherence to arbitrary fiscal rules over long term, productive investment curtials the ambitious investment required to build a low-cost and resilient domestic energy system. Meanwhile, the consistent underestimation of public spending multipliers in official forecasts continues to limit the government’s investment ambition, even in a world of slightly larger fiscal headroom. At the same time, the Bank of England relies narrowly on interest rate rises to address supply shocks it cannot fix. High interest rates have severe effects on growth and inequality, and keeping them higher for longer will only worsen the already dreary economic outlook.

“Our current fiscal framework constrains the public investment needed to deliver energy security”

The solution is to reform our macroeconomic frameworks to allow us to build economic resilience. This means creating space for the government to pull fiscal levers and for the Bank of England to pull monetary levers that complement each other, rather than working against each other.

Now is the time to capitalise on the new consensus around scrapping fiscal rules, and invest in resilience: from increasing the firepower of the National Wealth Fund and Great British Energy to finance home grown, green energy infrastructure, to scaling up funding for the Warm Homes Plan, to creating a strategic gas reserve to break the link between wholesale gas prices and energy bills.

A more flexible fiscal framework will also allow government to cushion households from the fallout of this energy price shock – millions of whom have been squeezed for years by high prices and high interest rates. There is time to develop a targeted and fair support package ahead of the July energy price cap that is more effective and targeted than the response in 2022. Inspiration can be drawn from our European neighbours, many of whom implemented an ​“energy block discount” – a more progressive alternative to the UK’s Universal Discount approach.

The Bank of England shouldn’t undermine this support with high interest rates that won’t address energy-shock-driven inflation. Alan Taylor, a key decision-maker at the Bank emphasised just last week that energy shocks have disrupted the Bank’s inflation targeting over last 70 years. It is increasingly being recognised that when it comes to supply shocks, fiscal policy is often best placed to tackle price increases. We will not weather these storms without better coordination between monetary and fiscal policy.

As we continue to be buffeted by shock after shock, it is people who are ultimately paying the price. The cost-of-living crisis will not resolve itself. It is the responsibility of this government to protect households from volatile energy and food prices, invest in resilient infrastructure, and ensure that public institutions are equipped to manage future shocks. As the world changes, the government cannot let outdated economic institutions leave its people exposed and its economy on the brink.

Image: iStock