The Bank of England has responded to rising inflationary pressures by increasing its policy rate four times since December 2021 from 0.1% to 1% and by starting ‘quantitative tightening’ of its balance sheet by no longer reinvesting the proceeds of gilt redemptions into new gilt purchases. As announced in February 2022, its holdings of sterling corporate bonds are also being reduced gradually, including through sales up to the end of 2023. As the policy rate reached 1% in May, the Bank announced that it would discuss a strategy for active gilt sales at the August 2022 monetary policy meeting. Monetary policy is expected to continue normalising, with the bank rate set to increase to 2.5% by 2023.
Fiscal policy has started to tighten, with the main pandemic support measures phased out at the end of 2021. Other measures, such as the temporary reduced VAT rates on hospitality and recreational services, ended on 31 March 2022. To return to a sustainable fiscal path, the government has committed to a gradual medium-term fiscal consolidation plan, with planned increases in tax revenues and increased investment. From April 2022, national-insurance contributions increased by 1.25 percentage points to fund health and social care spending while tax-free allowances and higher rate thresholds for income tax are frozen until 2025-26, a policy that now has a bigger positive impact on revenues than anticipated when introduced in early 2021 due to high inflation. From April 2023, the corporate income tax rate will increase from 19% to 25%. Due to rising energy prices, the UK government introduced a support package worth GBP 9.1 billion (0.4% of 2022-23 GDP) for 2022-23 before Russia’s invasion of Ukraine, to help households with rising cost of living. Measures include a non-repayable council tax rebate, a repayable energy discount and discretionary funding for Local Authorities to support households who need support but are not eligible for the Council Tax Rebate. Following Russia’s invasion into Ukraine, additional measures were taken, such as a 12-month cut in fuel duty. To reduce the burden on lower income households in face of increasing cost of living, the national insurance threshold is being raised in July from GBP 9 880 to GBP 12 570. An additional support package of GBP 15 billion (0.7% of GDP) was announced at the end of May, including a one-off GBP 600 payment to households on means-tested benefits, and one-off payments of GBP 300 to pensioner households and GBP 150 to individuals receiving disability benefits. Moreover, the energy discount was doubled to GBP 400 and turned into a grant. To help pay for the extra support, the government announced a new and temporary 25% energy profit levy for oil and gas companies, while also introducing an investment allowance of 80% to incentivise the oil and gas sector to invest in UK extraction. Overall, the fiscal stance will be contractionary and the underlying primary balance is set to improve by 1.8 percentage points of potential GDP between 2022 and 2023.
