A 0.1% fall in GDP may not mean much to most people – but it piles the pressure on the Treasury

We are only in the foothills of the economic pain to come, writes Anna Isaac

Rishi Sunak, left, and Boris Johnson will have to deal with the problems to come for households (PA Wire)

The UK economy shrank in March and it is easy to paint a picture of catastrophe. It’s a problem, because with forecasts suggesting this year will see the biggest fall in living standards since records began in 1956, this is really only just beginning to play itself out in the data.

With some quick to blame the cost of living crisis for rattling consumer confidence, it’s worth adding a note of caution: this data was from March. The new price cap for energy bills, which rose more than 50 per cent or an average of about £700 per household per year, only came into force in April, since when consumers’ confidence over finances has plummeted considerably.

Put simply, while many of the poorest households are already suffering, we are only in the foothills of a mountain of troubles to come over choices such as heating, eating or not managing at all.

The Treasury is not ignorant of this. Still, chancellor Rishi Sunak’s resolve to try to paint himself as a fiscally prudent leader requires a watch-and-wait strategy.

A month’s poor GDP performance will not see Sunak suddenly loosen the purse strings because he knows there is worse to come. There’s wisdom, those around the chancellor believe, in waiting to calculate just how bad things are going to get.

The course of energy price movements in the next couple of months will be critical to that strategy. This data is fed into the next round of calculations by Ofgem economists for the energy regulator’s price cap. This, industry leaders, including Keith Anderson, chief executive of Scottish Power, suggest, could take the average household bill to about £2,900.

The timing of this calculation could see the Treasury shift its strategy in early September when parliament returns from its summer recess. This would be a sensible moment to answer the clamour for an emergency budget, economists at Pantheon Macroeconomics have suggested, and some Treasury sources believe.

But businesses, particularly those in energy-intensive industries, will struggle to wait that long. They have to buy energy ahead of time. They do not receive the same energy price cap protections as domestic consumers. That leaves them vulnerable to market volatility.

And current events in Europe, including Russia’s war in Ukraine, will feed into prices that households will pay for energy this autumn and winter, because energy companies have to lock in purchases ahead of time and hedge against future market turmoil.

The price a consumer pays at the moment of use is often then the result of a lag between a wholesale market price point, and the energy company’s moment of purchase.

So if one looks at the headlines now with dithering, debate and political division in Brussels about imports of Russian gas, it’s clear that energy prices are set to bounce around, and potentially rocket further. The UK may have other energy sources, but it’s not immune to the tug of European and global energy markets.

Meanwhile, price growth in major economies, such as the US, is slowly revealing itself to be about more than just higher energy costs. In the UK, higher inflation – well above 2 per cent – even with the Bank of England looking to raise rates further in the months ahead, looks set to persist well into next year.

This makes the watch-and-wait strategy a gamble by No 11.

It may seem sensible to hold on to what limited firepower the public finances can sustain for the worst that is yet to come, but delay could increase the risk of a recession – so it’s a difficult balance for the chancellor to strike. Waiting risks making the cost of living crisis for the poorest households more acute, rocking the confidence of the middle classes who banked savings during the pandemic.

Consumers’ will hardly be made more confident by businesses being forced to pass on higher energy costs in their prices of goods and services, economists warn.

The words recession and crisis have almost been used too soon, when it comes to the whole UK economy – even though the struggle of poorer households has become acute. A small, 0.1 per cent reduction in GDP in March is a worry, but it’s not something that carries much meaning for most people. That’s going to change, sharply.

The £1.2bn that Labour believes could be gathered through a windfall tax on energy extraction giants would be a drop in the ocean, even if Sunak chooses to adopt it amid intense political pressure. Cabinet committees set up to try to offer cost-free ideas have so far struggled to find anything of the scale required.