The variable we need to watch? Gas prices

The UK faces “profound economic challenges”, said Prime Minister Rishi Sunak on Tuesday, in his first public speech since taking office. For far too many in the UK, the most serious economic challenge is making ends meet.

Inflation remains elevated, with the consumer prices index 10.1pc higher in September than the same month last year. Yet, to millions of households, the idea that the cost of living is up only a tenth on last year is a hollow joke.

That’s because the less well-off spend a higher share of their incomes on basic foods, fuel and other essentials. And the price of such goods has risen far faster than the headline inflation indices.

Vegetable oil cost £1.56 a litre on average in September 2021, according to the Office for National Statistics.

Last month, that same litre bottle was £2.58 – 65pc more expensive. A half kilo bag of pasta was 61p last month, up from 38p a year ago – a 60pc rise. Tea is 45pc dearer than a year ago, while the price of milk is 30pc up.

Filling a car is 23pc more expensive than it was a year ago, a litre of unleaded petrol having risen from £1.35 to £1.65 – and for many low-income families, in rural areas in particular, a car is by no means a luxury.

Fuel costs for van drivers have soared even more, with diesel up from £1.38 to £1.81 a litre over the past 12 months, rising almost a third.

Yes, the consumer prices index hit a fresh 40-year high last month. But for millions this cost of living spike is far more serious than official inflation rates suggest.

That’s why Rishi Sunak faces such a challenge – with efforts to stabilise the UK’s public finances set to be imposed upon a population, large sections of which are already struggling. The UK economy meanwhile contracted at its fastest pace in almost two years in October, pointing to looming recession – two successive quarters of negative growth.

The composite CIPS index, a measure of private sector commerce, dropped from 49.1 to a 21-month low of 47.1 – the third consecutive reading under 50, a majority of firms reporting a contraction in activity. As the cost of living spirals and the pace of economic decline gathers momentum, this is indeed a tough time to be taking over as Prime Minister.

Maybe that’s why Boris Johnson decided (for now) against a second stint in No10. Having secured the one hundred MP nominations, he could have forced a vote of rank-andfile Tory members between him and Sunak, a vote he probably would have won.

Amid this doom and gloom, there are chinks of economic light. As government borrowing costs ease, the UK’s public finances are shifting from the “moron premium” to the “dullness dividend”.

Prior to last weekend, with Johnson set to make a dramatic comeback, the pound was around $1.11 and the 10-year gilt yield – the annual interest rate demanded by investors to lend the Government money for a decade – was around 4.2pc. This was sharply up from 3.5pc ahead of the infamous mini-Budget a month earlier, which sparked the ejection of then chancellor Kwasi Kwarteng, soon to be followed by Liz Truss as prime minister.

The markets had been partially mollified by the replacement of Kwarteng with Jeremy Hunt, yields retreating from 4.5pc after he vowed to a host of revenue-raising measures, including a sharp rise in corporation tax.

But still, the prospect of yet another Tory leadership scrap, with the free-spending, mercurial Johnson regaining the keys to power, put a premium on borrowing costs.

After Johnson bowed out, though, the 10-year yield dropped from 4.2pc to below 3.5pc over less than a week – an astonishing shift in such a short time. The confirmation of Sunak saw the pound rise almost 2pc in a day, touching $1.16 at one stage, its highest since mid-September, prior to the mini-Budget.

For now, global investors seem to favour the “dullness” of promised fiscal consolidation and a Goldman Sachs alumnus in No10 over “Trussonomics” – slashing taxation and going for growth. It remains to be seen if the UK’s broader population agrees.

Even with Hunt having dismantled large parts of the Kwarteng/Truss tax-cutting programme, analysts still point to a gaping £40bn annual hole in the public finances. That’s why Sunak and Hunt are right to have moved the upcoming fiscal statement from Oct 31 to Nov 17.

Making this shift demonstrates the Government is back in charge, with ministers, not traders, dictating events. It also avoids holding a tough financial statement on Hallowe’en – which was never a good idea, albeit a headline writer’s dream.

By delaying, and turning the announcement of fiscal plans into a full Autumn Statement complete with full forecasts from the Office for Budget Responsibility, Sunak and Hunt are trying to bring these weeks of financial turmoil to close, a welcome return to normality.

Crucially, given what we’ve seen since over recent days, the OBR should now be able to use lower projected borrowing costs in its forecasts, reducing annual state spending on debt interest, potentially, by tens of billions of pounds.

The Government’s finances remain tight – one reason ministers have signalled they may not uprate the basic state pension by the 10.1pc CPI inflation rate, breaking a 2019 manifesto pledge. I suspect that inflation upgrade will ultimately happen, not least as Tory MPs, mindful of the power of the “grey vote”, would otherwise rebel. And the good news is, if gilt yields remain contained, Sunak’s fiscal tightening may not be as painful as previously thought.

The real index to watch, though, the variable that will indirectly drive politics over the coming months, is the price of gas.

Wholesale prices dipped below €100/MWh last week – still historically high, but sharply down since the summer and lower than before Russia invaded Ukraine.

If gas prices stay where they are, the energy price cap for firms and households – the issue that really spooked financial markets – will cost much less than expected to deliver, providing much more fiscal room for manoeuvre.

But if gas prices spike anew – which could happen due to a whole host of geopolitical factors – the UK’s public finances and borrowing costs, to say nothing of our politics, will once more be convulsed.

‘The idea that the cost of living is up only a tenth on last year is a joke, because the less well-off spend more of their incomes on essentials’