The chancellor must use the budget to tackle inflation

In a week’s time, Chancellor John Healey will stand at the dispatch box and reveal how willing this government really is both to support people through the cost-of-living crisis this winter, and to grip the UK’s inflation problem.

Living standards are due to decline faster than over the course of any parliament since records began. Meanwhile, inflation is now projected to reach 4% in 2027, colliding with the delayed impacts of a historic El Niño weather event that will push up food prices even more next year. As a result, financial markets expect the Bank of England to raise interest rates four times by the end of 2027, starting as soon as this November.

This government has the ability to act. By delivering a cost-of-living package that lowers the costs of essentials like energy, housing and transport, Healey can directly lower the consumer price index – the headline inflation measure – taking pressure off both households and the Bank of England. The Bank interest rate and inflation uncertainty are both key drivers of government borrowing costs, meaning that a cost-of-living intervention can ease the cost of government debt too.

What does lowering the cost of essentials look like? Private renters spend around a third of their income on rent, rising to around half for the poorest fifth of renters. Energy bills this winter are on course to exceed their 2022 – 23 peak. Despite recent fare caps, bus fares have far outpaced inflation for a quarter of a century. The chancellor can tackle these costs directly with a national energy guarantee, an emergency brake on rents and cheaper bus travel, funded by fairer taxes on wealth and corporate windfalls.

These measures take the pressure off household budgets while also lowering the official inflation rate. Some may argue that with extra money in their pockets, households will spend more, pushing prices back up. But if these policies are tax-funded and, given that UK demand is currently weak (meaning that people are not spending much), any extra spending power is more likely to kickstart the economy than overheat it. Indeed, as new research finds that the UK’s weak growth since 2010 may owe far more to a lack of demand than official forecasters assume, and boosting demand could be exactly what the economy needs to get moving again.

A lower inflation rate means the Bank is less likely to raise interest rates, which would otherwise be passed on to people paying mortgages and rents. The Bank’s July Financial Stability Report projected that just over 5 million households will see mortgage repayments rise by the end of 2028, and that was before recent rises in rate expectations. Moreover, high interest rates make it more expensive to invest in the clean energy and energy efficiency which shields us from future energy price shocks. Monetary policy committee member Swati Dhingra recently commented that, ​“Higher interest rates will not reopen a blocked strait, replace a sanctioned supplier, or mend a trade relationship. This matters for how we think about the appropriate policy response.”

Lower inflation means lower interest rates, which means lower borrowing costs, which means more investment in resilience, which means lower inflation in future: a virtuous circle. Lower inflation risk means investors demand less for government debt (known as ​“gilts”) and the cost of inflation-linked bonds (known as ​“index-linked debt”) fall, easing the pressure on our public finances. In other words, tackling the cost of living now creates the fiscal space Healey needs to deliver this government’s longer-term plans to rebuild the economy.

In this country, macroeconomic constraints like government borrowing costs, debt levels and inflation are often perceived as the villain that we can do nothing about. They are pitted against any attempts to improve peoples’ lives: we are told that the government has no room to manoeuvre because resources are scarce, bond markets are sensitive and borrowing costs are too high. But a closer look at current conditions points to a different conclusion. These constraints are real, but they are not beyond this government’s influence, and tackling the cost of living is one of the most effective ways to loosen them.

None of this means there are no trade-offs or risks, including political ones. The chancellor has made a decent cost-of-living package harder to fund by reportedly ruling out equalising capital gains tax with income tax, a reform that could have raised £19bn a year. We live in a volatile world, and unforeseen shocks can blow inflation-dampening measures out of the water. Price controls can backfire if they are poorly designed or not paired with structural reform. But inaction is no longer an option, either for people or for macroeconomic stability.

Since 2021, the UK has met each inflation shock with a patchwork of emergency support and steep interest rate rises, leaving households and public finances exposed to the next shock that comes along. Andy Burnham has promised an end to this doom-loop and the budget is a chance for his chancellor to prove he is serious. If the government can grip the cost of living, it can then get to work rebuilding the British economy.