Why the energy crisis is expected to derail the UK economy in 2022

Friday 07 January 2022 15:10

As households brace for higher tax bills and are already stung by soaring food prices, rising energy costs will hit the hardest in 2022

A wave of concern over the rising cost of living is sweeping through Britain.

As households brace for higher tax bills and are already stung by soaring food prices, rising energy costs will hit the hardest in 2022.

UK gas benchmarks have quintupled since January 2021, from £ 54 per therm to £ 245 per therm in December 2021.

While the tensions between Putin and the West may seem like a distant political intrigue found in a lukewarm spy novel sold at an airport, the reality remains that national energy costs are tied to European political stability.

Britain imports a large part of its gas supply from the continent which, in turn, depends on Russia for around 35% of its own natural gas flows.

When relations between Moscow and Brussels break down – as they are now – the UK energy market often enters a period of volatility.

Britain is making progress in the domestication of its energy supplies to address this problem.

The UK is expanding into a diverse range of energy sources such as hydrogen and nuclear power in its drive to reach net zero by 2050 and relax its green credentials after welcoming the COP26.

But its main source of renewable energy is wind power, which is volatile at best. In a windless winter unusual for the season, it significantly underperformed, leaving the UK increasingly dependent on gas exported from Europe.

The energy market is very inefficient due to government policy intrusion.

Businesses are severely constrained by price caps that often cause them to produce energy at a loss, the main reason a wave of suppliers has fallen into the wall.

Bulb, the UK’s seventh-largest energy company which recently came under administration, was buying gas at £ 4 per therm, up from 50 pence per therm a year earlier. However, the price cap, set at £ 1,277 per year for average use, meant they could only charge consumers 70p.

The weak watchdog of the Ofgem watchdog has allowed a flood of fledgling companies run by people inexperienced in the energy market to flood space.

As a result, smaller energy companies have failed to hedge properly in a desperate attempt to drive out customers, leaving them exposed to sharp hikes in gas prices.

The energy crisis has already affected millions of Britons, but is expected to hit more.

Fund manager Investec, meanwhile, predicts that domestic consumers will have to pay £ 3.2bn for the collapse of energy companies – an average of £ 120 per household.

The price cap was increased by 12 percent last October. Ofgem is expected to announce its next one on February 7, and City analysts expect it to climb at least 50% this time around.

Raising the energy price cap will put enormous upward pressure on UK inflation.

In fact, most City economists, and even the Bank of England, believe the cost of living wouldn’t even come close to their forecast if gas prices hovered around their historically low levels.

Nonetheless, the Bank has bet on an inflation spike to 6% in April when Ofgem’s price cap decision goes into effect.

However, City experts believe the Bank has underestimated its inflation estimates and expect the energy watchdog to raise the cap even further.

Pantheon Macroeconomics, a consultancy firm, presented several scenarios, each examining how inflation might move depending on the magnitude of the price cap hike.

In a more optimistic prediction, Ofgem raises the cap to 46.5%, pushing inflation to 6.2%. However, in a darker scenario, the cap is raised by 54 percent, bringing inflation to 6.4 percent.

Investment banking giant Goldman Sachs also estimates the price cap could rise by up to 50%, but warns the cost of living will rise to 6.8%, the highest level in recent history .

Investec believes the price cap will rise by 56%, lowering the average energy bill from £ 1,277 to around £ 2,000 per year.

The UK energy market, subject to a period of volatility, has the effect of weighing heavily on real household incomes.

The Resolution Foundation, an economic think tank, warned that a combination of impending tax hikes, soaring inflation and higher energy costs would erode Britons’ standard of living, prompting the organization to dub 2022 “l ‘year of compression’.

The burden of a higher cost of living will fall mainly on low-income households, as they tend to spend a greater proportion of their income on essentials.

However, richer households will absorb the harshest financial shocks of the impending 1.25 percentage point increase in national insurance contributions, as they tend to have higher employment rates.

The corrosion of UK finances is therefore widespread, casting doubt on the ability of consumer spending to bring the UK economy back to its pre-pandemic size.

Household budgets for spending on non-essentials will shrink as they divert more money to paying higher energy tax bills.

The UK relies heavily on consumer spending to generate production, indicating that the economy could still be in a quagmire as spring approaches – just as the cost of living blizzards and rises. of the energy price cap are expected to materialize.

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