The future of the triple lock could be at risk amid economic chaos sparked by the Middle East crisis, experts have warned.
A former Bank of England insider predicted that interest rates are likely to be raised twice this year in a bid to avoid a spiral in inflation.
Michael Saunders, who previously sat on the Bank’s Monetary Policy Committee (MPC) which sets rates, also said that if markets start to worry about the UK’s public finances the case for controlling both public finances and inflation would be strengthened.
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The Resolution Foundation has calculated that Rachel Reeves’s borrowing rules will not be broken this year despite the economic damage being done by the US-Israeli war with Iran. These state broadly that daily expenditure should come from general taxation and not borrowing, with debt falling.
The conflict, which has hit energy markets because of a shortfall in exports of oil and gas from the region, has already pushed up inflation to 3.3 per cent thanks to higher fuel prices.
UK ‘particularly sensitive to global news’
Simon Pittaway of the Resolution Foundation pointed out that Britain’s borrowing costs on international markets had risen more rapidly than those of most other comparable countries.
He said: “There’s a continuation of this long-standing trend where UK rates have been particularly sensitive to global news, and we think that reflects the risk of sticky inflation, as evidenced by the experience of the last five years, and also concerns about our public finances.”
Saunders warned of a risk that markets could take fright at the ability of the Government and Bank to control the economy in the event of prolonged global turbulence. He said: “We’ve talked about how we’ve had this series of inflationary shocks. So inflation is much more volatile.
“One of the consequences of that is that the cost of the triple lock is much higher than expected, because the cost of it is directly linked to inflation volatility. Is that something which, in that kind of outcome, having a look at that would help to reduce some of the UK’s longer-term fiscal vulnerabilities?”
His view was echoed on Wednesday by a note from consultancy Oxford Economics to its clients, in which chief UK economist Andrew Goodwin said: “We think the triple lock is unaffordable and should be replaced by indexation to earnings.” This would become “more pressing” if ministers succeeded in their goal of cutting net migration, Goodwin added.
The triple lock states that each year the state pension rises by the same rate as inflation, average wage growth or 2.5 per cent – whichever is highest. It is opposed by many economists who argue that it guarantees pensions will become unaffordable over time, but is supported by all political parties and a large majority of voters.
Risk of persistently higher prices
High inflation over recent years has seen a series of bumper state pension rises and the annual bill is expected to be £146.1bn for this financial year.
The growing clamour to increase defence spending has also put the pension bill under the spotlight. Earlier this month former Labour deputy leader Harriet Harman suggested the Government should look at means-testing the triple lock policy in order to raise more money for defence.
Saunders said that while the latest surge in inflation was tied to temporary factors, there was a serious risk of persistently higher price rises because of the past few years which have seen much worse inflation than over the previous decade.
He predicted that the Bank would respond by raising rates, saying: “I think there’s a reasonable chance we’ll get some tightening this year – pencil in a couple of hikes, probably not next week, I think more likely one in June to September, one perhaps in the fourth quarter this year.”
Two quarter-point interest rate increases would leave the main rate at 4.25 per cent and push up the cost of borrowing for a mortgage. Before the start of the war in Iran, the Bank was widely expected to cut rates further this year.