Oil prices climbed sharply on Thursday, driven by reports of military clashes between Saudi Arabia and Houthi forces, adding pressure on UK policymakers as they prepare the government’s budget. The price of Brent crude rose nearly 5% to $108 per barrel, intensifying concerns within the Treasury about economic management in the coming months.
Government officials have indicated they have reduced fiscal flexibility compared to earlier assessments, prompting urgent work on potential consumer support packages. The focus is particularly on preparing for a significant jump in the energy price cap scheduled for January, which the Bank of England projects could increase by as much as 24%. Any assistance package is anticipated to be more targeted than the broad-based subsidies implemented by Liz Truss in 2022, with officials considering options such as reallocating green energy subsidies into general taxation or directing help toward lower-income households, though some question the effectiveness of means-tested approaches.
Central bank officials have warned that persistent high energy prices could force interest rate increases despite the government’s economic challenges. Bank of England chief economist Clare Lombardilli cautioned that elevated energy costs pose risks of broadening inflation effects and wage pressures, potentially requiring monetary policy tightening if prices remain high. Similarly, deputy governor Sarah Breeden noted that prolonged shocks increase the likelihood of second-round economic effects demanding policy responses.
The combination of higher energy prices and inflation concerns has triggered a global sell-off in government bonds, raising borrowing costs for the UK and other economies. The yield on 10-year UK government bonds reached 5.39% on Thursday, approaching a 19-year high. This bond market deterioration has eroded much of the fiscal headroom the Treasury had built up, with analysts estimating that more than half of the £24 billion buffer against fiscal rules has been eliminated by recent yield increases. While the Chancellor has committed to meeting fiscal rules with a cushion against uncertainty, rebuilding the original headroom would likely require substantial tax increases or spending reductions.
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