Oil prices surged nearly 5% to $108 per barrel on Thursday following reports of military escalation between Saudi Arabia and Houthi forces, presenting significant challenges for the UK government as it prepares its budget next month. Treasury officials acknowledged that the price spike has reduced their fiscal flexibility compared to conditions a month earlier, prompting an urgent review of policy responses to protect households from potentially sharp increases in the energy price cap expected in January.
Government options under consideration include restructuring green subsidies to be funded through general taxation or concentrating assistance toward lower-income households, though some officials question the effectiveness of targeted approaches. Officials emphasized that any support package would be substantially more limited than the broad subsidies introduced by former Prime Minister Liz Truss in 2022, and would build on existing measures such as the electricity VAT reduction previously implemented.
The Bank of England has heightened concerns about inflation and monetary policy, with Chief Economist Clare Lombardelli warning that prolonged elevated energy prices increase the likelihood of future rate increases if other economic indicators do not show improvement. The Bank’s estimates suggest the energy price cap could rise by as much as 24% at the start of the year. Deputy Governor Sarah Breeden echoed these concerns, noting that extended energy shocks could trigger secondary effects requiring policy adjustments.
The situation has also affected financial markets, with 10-year UK government bond yields reaching 5.39% on Thursday and approaching recent peaks. Analysts estimate that recent market movements have reduced the government’s fiscal headroom by more than half from the £24 billion available at the time of the spring statement. The broader bond market has experienced significant volatility as investors reassess risks related to Middle Eastern conflicts, US fiscal spending concerns, and other factors affecting government debt across major economies.
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