Prepare to get poorer in 2022…

Forecasting is difficult, as they say, especially for the future. Yet a pair of ugly twins is visible, in the shape of inflation and interest rates, which are likely to dominate the political and financial debate in 2022. Inflation is already with us, and measured by the “discredited” but widely followed Retail Prices Index, is running at over 7 per cent. The generation-long fall in the cost of money appears to be coming to an end with the symbolic rise in Bank Rate. More significant rises look nailed on.

The runaway price of gas will ensure that inflation stays high into the spring.The formula for the domestic price cap will impose another rise on consumers just as the rise in National Insurance hits pay packets in April. This rise is another government sleight of hand. Billed as 1.25 per cent, it is in fact a 2.5 per cent payroll tax increase when the parallel rise in employer’s NI is added in. 

Furthermore, it is not paid by those who are retired, regardless of income. It is neither national nor insurance but a dishonest way of taxing the income of those of working age. The Resolution Foundation calculates that the rise will cut an average of £600 from next year’s wages, while it expects fuel bills to go up by the same amount. The trades union leaders’ description of this as a “cost of living catastrophe” is hardly an exaggeration. 

This pincer movement of rising prices and falling incomes will force government action, and recycle some of the extra tax raised from NI into unplanned spending. A direct payment to poorer households is bureaucratic and certain to have awkward side-effects. The cost of the subsidies to wind and solar, long buried in the gas bill, has been exposed, revealing the real price to consumers of the dash to go green. The renewables lobby is pressing for the subsidy to be moved to general taxation, which would conveniently allow the true cost to disappear from public view once more.

The neatest way to soften the blow would be to take VAT off domestic energy, as the Conservatives once promised to do, before the European Union’s VAT rules prevented any cut below today’s 5 per cent.

This would do nothing for the underlying problem – indeed, any attempt to keep the price down would stimulate demand – which is the failure to exploit Britain’s own reserves. It’s worth repeating that the British Geological Survey estimated the Bowland basin gas reserves under north west England at 1300 trillion cubic feet (central estimate); extracting just 25 trillion would be worth £1 trillion at today’s elevated prices. There are still fields in the North Sea which are commercial if the climate change hysteria can be faced down. It would take political courage of an order not seen by this administration to do so.

Whether domestically or elsewhere in the world, today’s prices will stimulate a frenzy to find more hydrocarbons, just as the prices of the exotic metals needed for electric cars are stimulating efforts to find them outside China. In commodities, the key phrase is: Today’s shortage is tomorrow’s glut. 

If you wish to be optimistic about inflation in 2023, here is Capital Economics’ Commodities Watch: “While there isn’t a single cause of these shortages, there is one common theme: in all cases, prices now appear to be close to a peak (if they haven’t peaked already). The prices of commodities which have risen most are likely to see the largest falls over the next year or so.”

So it is likely that today’s inflationary surge is just that. The monetary background is ominous, but few of the other conditions for a sustained rise in prices are present. Labour is organised only in the public sector, as the trades unions have failed to make headway recruiting in the productive sectors of the economy. The shortage of components, most obvious in microchips, is already stimulating investment in new capacity across the world, which implies a glut in 2023.

None of this will prevent the steady rise in interest rates which is needed to bring the economy back towards a balance between capital supply and demand. Dearer money will accelerate bankruptcies of zombie businesses which have been kept alive by free money, and start to show the cost of the government’s fiscal incontinence. Rising interest rates should, eventually, stop the runaway inflation in house prices, but the impact on the public finances will be quicker and more dramatic. 

Economist Michal Stelmach at KPMG expects three further Bank Rate rises by the end of 2022-23, which “could add as much as £11bn to borrowing that year.” On the other hand, the stock market is signalling that the UK economy will put in a sprightly performance, as the forced savings from the pandemic start to get converted into holidays, nights out and new cars for old. The new year may make us poorer, but if the state of the public finances forces more prudent behaviour from this fiscally incontinent administration, it may yet be worth while. 

It’s an ill wind

It is impossible to miss the ads for cheap champagne, sandwiched between exhortations to get jabbed. The shops are stocked with the stuff which they expected to sell to restaurants and clubs over Christmas before we decided to hunker down at home. Sainsburys still have some Heidseck for £14, although the offer of a further 25 per cent discount for a dozen evaporated before you could get the capsule off. Tesco’s £10 (Clubcard) De Vallois lasted little longer. Nicholas de Montbart is £12.49 at Aldi, Comte de Senneval £13.99 at Lidl.

You have never heard of any of them, but it doesn’t matter. Supermarket champagne should not be drunk on arrival. Keep it for a year, or preferably longer, and be amazed at how it has transformed into something you can offer your friends which they won’t empty into the nearest potted plant. 

Fizzy New Year!