263. Iran War: protecting the UK economy from the energy crisis

0:00We are seeing in all financial indicators, you know, warning signs flashing red. You know, this is now a national emergency. What are we prioritising here? Is it net zero? Is it growth? Can it be both?

0:27hello and welcome to the rest is money with me Robert Paxton and with me Steph McGovern so this is another special episode for you focused on the economic impact of the war in the Middle East as We're now entering the fourth week. Oil price is still over$100 a barrel and no sign of the blockage in the strait of Hormuz easing. And just to remind everyone, that's, you know, the world uses about 100 million barrels a day of oil and about 20 million of that goes through that strait. And so far, analysts are saying since this war started, about 440 million barrels have been stopped going through there.

1:04So that's where a lot of this economic impact is really starting. So in this episode, we're going to talk about what Trump's been saying about it all, what it means politically for us. Then we'll focus on the UK economy and how it could impact it. Now we know, you know, now this war's continuing, what the impact is for borrowing costs for the government, for consumers, what Starmer and Reeves want to do about it and at what cost and what it might all mean for the autumn statement, which people are now talking about whether we might see more tax rises. And we'll give you a flavour of what business leaders are saying in all of this too.

1:42So, Robert, lots to talk about. If you are listening to this in the early hours of Tuesday morning, you will have a clearer view of a very, very important question, which is whether this conflict is massively escalating, because we are recording just a few hours before Trump's deadline expires for the Strait of Hormuz to be reopened by Iran. And what he has said is that if the strait is not reopened, then the US and Israel will bomb and obliterate power generation in Iran, depriving Iranian people of electricity and power, which would be a massive escalation. there are some circumstances where destroying power plants is sort of deemed a war crime and you know we've been acutely aware of the sort of horrors of oblitering power plants because of course we've seen Russia do this in Ukraine you know as we speak we are obviously the world you and I feeling very anxious about how much worse this could get and in the meantime we are seeing in all financial indicators, the warning signs flashing red.

3:15And one of the things we probably need to talk about today is why these warning signs appear to be, among the rich countries, among the so-called G7 developed democracies, why the impact appears to be worst for Britain. Because it is, in the sense that our borrowing costs, as measured by the fall in the price of government debt, the rise in the implicit interest rate that the government has to pay has been rising more than in other countries. And then this is feeding through to other measures. You know, the overnight interest swap, the OIS, is showing potentially three interest rate rises by the Bank of England this year.

4:07And you'll remember, before the conflict started, we were expecting at least two cuts in the interest rate. And you'll be acutely aware if you're buying a property or refinancing a mortgage, what a nightmare time this is. Because, you know, mortgage rates have absolutely shot up, haven't they, Steph? Yes, because funnily enough, just before we started recording, because I am in the middle of buying a property, I just double check with my broker. We have definitely locked in this rate, haven't we? And we have, because what you've seen is, you know, if you look at Moneyfax put out what the kind of typical rates are being offered now.

4:49So just to give you an example, a typical two year fixed rate is now at 5.3 percent and it was 4.83 percent only a couple of weeks ago. and you know that that and now as you say we were talking about rate cuts uh we know in the last meeting the rates were obviously held at 3.75 but people are now talking about them possibly getting to 4.5 by the end of the year which is a huge turnaround from from where we were just in a couple of weeks just from what is going on in a you know a part of the world that's hundreds of miles away from us it's quite incredible really isn't it yeah we're going back to mortgage rates you know were very normal when you know i was a young person buying a house but you know we haven't really seen since the global financial crisis these are very very high mortgage mortgage rates um and equally the government i mean the for the government to borrow for more than 10 years which is the sort of benchmark so-called guilt rate, it's now over 5 % and holding, which, as I say, is a borrowing cost for the government that, again, we just haven't seen since the time of the global financial crisis.

6:12So this is a big shock to the affordability of debt, a big shock to the economy. and and it's worth saying because you you preface this at the start by saying you know why are we different to other countries on that point and it is because of our dependence isn't it on imported energy and how quickly that could feed through into inflation you know it's a huge problem for us how much we have to bring into this country it's a number of things and that is obviously the The dependence, you know, the UK's relative dependence on imported energy is obviously very significant. But actually, I think there are other factors which I think are also very important.

6:56And I think it's probably important to explore that in some depth. And maybe we should do that after this quick break. This episode is brought to you by Octopus Energy. Now, you know, we love talking to entrepreneurs on this show. So with us is the founder of Octopus Energy, Greg Jackson. Right, I'm going to start with this. If you could change one thing to help Britain's economy grow, what would it be? I'd love to see pension funds putting more money into British businesses. Over the last 25 years, they've fallen from 40 % of their investments going to British businesses to 4%. That's bad for business here.

7:31It's bad for our stock market. But it's also bad for pensioners. In fact, a Canadian pensioner will get almost double the pension from the same amount invested as a British pensioner. We need to sort that. Nice one, Greg. Well, thanks to Octopus Energy for powering this episode of The Rest is Money. This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed Sponsored Jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate seat. According to Indeed data, Sponsored Jobs have four times more applicants than non-sponsored jobs.

8:06So go build your dream team today with Indeed. Get a$75 sponsored job credit at indeed.com slash podcast. Terms and conditions apply. Today we helped a... Latte for Sam. ...coffee shop get an insurance quote simply and easily. And made sure... A floral delivery van was able to make someone's day. We're the Hartford, with decades of experience insuring millions of unique small businesses. When it comes to your small business insurance... Thank you. One size absolutely does not fit all. Get a quote or find an agent today at thehartford.com slash small business. So the fundamental reason why we are so vulnerable in these circumstances, you know, it stems from a number of related factors.

9:01But the most important one is simply that, you know, we have a very weak economy. Growth has been low to non-existent for years and years and years. You know, we also have a structural problem in that we've got, you know, very, very large numbers of people on low incomes who when energy prices go up and when there are knock-ons to food prices, for example, which is what we expect, then the pressure on their living standards is intense. We have a government that will feel under an enormous amount of pressure to increase benefit payments to these people or at least subsidies for what they pay when it comes to energy of a substantial sort, all of that at a time of low growth, growth which may well tip into recession because of what's happening to interest rates and input costs, means that tax revenues will be falling and therefore you get this sort of negative gearing effect where basically this all translates back into higher borrowing.

10:26And at that point, obviously, lenders to the UK become focused again on whether the debt burden for a government that has debt equal to about 100 % of our national income is sustainable. You know, debt burden here, as I say, around 100%. In a place like Germany, even though Germany's got a massive low growth problem, you know but its debt burden is way less tens of you know 60 70 percent of of GDP so it starts in a much stronger position in in that very important sense and at the root of all of this this is the sort of tragedy for the UK is this fact that we are massively growth challenged This has been absolutely conspicuous to a whole series of governments.

11:18It was something that this government was acutely aware of when it was campaigning in the last general election and has just done way. You know, it's one of the things I've just sort of bang, you know, been banging on about week after week. More or less since we started this podcast. us um growth is is so important particularly at these times of of shocks in terms of um essentially giving confidence to our creditors and the fact that the government has done too little to reform the so-called supply side of the economy in a fundamental way um to get the you know implicit growth rate up is why we are so appallingly vulnerable and it's a sort of scandal I mean, in a way, the one thing my dad was an economist said, don't cry over spilt milk.

12:09And it is true. The milk has been spilled. So let's not wring our hands, I suppose, too much about the failure of the government to do that. But the fact is, along with everything else that it's got to do, this is the moment where it cannot waste the crisis. If it can't now take the kind of radical measures to really get the growth rate up, then, you know, we've got big problems. Yes. And just, you know, on that, I think part of the problem is the heavy taxing on business in that very first budget that Rachel Reeves did. You know, it was really was like a three pronged tax hit for lots of businesses, particularly in the retail, hospitality, fitness, leisure area where you were hit by business rates going up, by minimum wage going up, particularly on young people, by national insurance contributions going up.

13:02It came at all angles at the same time. And that, you know, has put a lot of pressure in. We've talked before about the kind of zombie businesses as well. So these businesses that are not particularly growing, they're not they haven't got great productivity, but they're still giving people jobs and they've done well off cheap credit. And now that credit's going to go up in cost, they're going to be pushed into being out of business. And you could argue that that's not a bad thing if it helps productivity, but it's still probably going to be people out of work. And we do have rising unemployment, particularly young people.

13:35I am so worried about young people out of work, the million that are so neat we have not in education, training or employment and just the pressure on that. And I'm seeing this firsthand in our retail business. You know, we're looking at one of our stores now. It was it was doing really well. There were great margins in it. But now it's costing us five hundred pounds a day to keep it open. And we're like, well, that doesn't make business sense for us anymore. You know, there's others where it's fine. it's doing really well but because of that kind of three areas all going up at once you you're then like you know your margins are getting really tight and so then there's a question of is it worth it with uh you know with businesses as well so there'll be lots of people in all kinds of industries talking about how they're going to deal with this latest pressure of energy bills going up of you know oil prices going up of of inflation on food costs and everything else because it all hits us really hard and that's my worry about this so the question i want to ask you robert in all of this is you've said this is now the time to act does that mean she should forget about the fiscal rules it should she stop thinking about you know only borrowing um to invest and not borrowing for day-to-day spending does she need to just forget about that and think right let's put money in and get things going again?

14:58In the short term, that would be the fast route to the mother of all debt market car crashes. I mean, interestingly, you're not the only person who has been thinking along these lines. There was what's called a political cabinet a few days ago, which is where the cabinet meets to discuss, you know, the sort of more party political issues rather than straightforward government business. And at that, you know, a minister said to me that Lisa Nandy, the culture secretary, who is a very good communicator, she said that this was the time to, you know, relax the fiscal rules, loosen the restrictions on the government's ability to borrow.

15:51I have to say that Although there's a perfectly good theoretical discussion to be had about whether these fiscal rules are the optimal fiscal rules, we are where we are. And if we saw the government at this juncture loosening those fiscal rules, the more than 5 % that it's paying to borrow for 10 years, I mean, goodness knows how high that would rise. What if it came with a growth plan, though? Because that's what markets want. They want to see that you're going to grow. So what if the money was then, it was shown that it could grow? OK, but what Liz Truss showed is you can't put the cart before the horse, right?

16:37If Liz Truss had not announced all those massive unfunded tax cuts to the tune of whatever it was,£40 billion, pounds and then instead just concentrated on pushing through reforms to planning regulations you know you know other forms of burdens on investment for example then and then at a later stage let's say a year 18 months later announced quite considerable tax cuts you know at that point lenders to the UK might have taken the view, OK, she has done some very difficult things to improve the productive potential of the UK economy. We now do believe that the economy is on a sustainable path to grow a bit faster without spiking inflation.

17:34And at that point, she might have been able to get away with those tax cuts. But what you can't do at a time when inevitably borrowing is going to be rising because of the cost of sheltering people from these energy price shocks you know at a time when that's going to be happening okay to simultaneously say and by the way we are going to be subject to less fiscal discipline um you know we would be back in a liz trust style fiscal crisis where you know you could get even to a position where, you know, the government's sales of this debt, actually, you know, its fundamental ability to borrow could be really fundamentally undermined.

18:22So, you know, I mean, one of the reasons, I mean, just to be clear, one of the reasons, I mean, I've talked about some of the other structural reasons why, you know, our borrowing costs are so much higher than our competitive countries. Okay. But a contributor to that is that Keir Starmer's hold on office personally is considered to be weak. And broadly, markets take the view there is a very high probability that he and Rachel Reeves will be turfed out after the local and Scottish and Welsh elections on May the 7th. They think there's a high probability of that, and they do worry that whoever replaces Starmer will indeed weaken or abandon those fiscal rules.

19:05And they are they are currently sending a warning to the UK by pushing up the interest rates that, you know, of what could happen were those rules to actually be shredded. So, you know, I'm not remotely arguing. And, you know, I did think that when she reformed her fiscal rules, you know, these were not optimal, her changes. And if she'd done something a bit more creative that had led to an ability to invest more, you know, at the time that she changed her fiscal rules in a different way at the end of 2024, that would have been, you know, in my view, a good thing. But it's too late. Right. She and the government are now imprisoned in the rules of their own making.

19:49And until we actually see the reforms that will lead to higher growth. Right. And they are they are they are a variety of things, but they are mostly about looking at more radical reform of planning, more intelligent reforms, reworkings of the kind of regulations that affect investment and business. They are about doing going further and faster in providing scale up finance to the kind of fast growing businesses that we are still creating, but can't grow fast enough and too often relocate to countries like America where the finance and the people are there. They are about moving further and faster in attracting talent to the UK.

20:35They are about providing the kind of tax breaks to businesses that allow them to invest in growth areas. You know, and then with the big infrastructure changes that they're talking about, whether it's, you know, the Oxford Cambridge corridor, whether it is the Northern Powerhouse corridor. It's about massively accelerating all of that. I mean, part of the problem that this government has got is they are doing some things that will lead to higher growth. But, you know, it's happening slowly and none of it really will translate into the growth rate. So it well into the next parliament, which is way too late.

21:15So, you know, they should do that thing that I talked about repeatedly. And this is the moment where they should. I mean, I think there's an argument saying you should legislate for this. You should in this crisis. But what they should do is they should basically say every department that is doing any kind of legislation that has an impact on whether people save or spend or businesses invest or hire. Every single one of those initiatives should be assessed for whether it encourages growth or reduces growth. And if it reduces growth, it should only go ahead, in my view, if the prime minister personally gives permission for that.

22:02And, you know, in other words, the presumption should be the only measures that they can now take are those that will increase the structural growth rate of the UK. And, you know, there may be things for the welfare of people that you have to do that are not growth enhancing. but the prime minister's mind has to be totally focused on is that a trade-off lower growth for helping a group of people that is worth making and as i say i would i would even just to demonstrate to the world you know the intent i would even legislate so that you know that that was absolutely an obligation for the entire cabinet so there's a few things i want to come back with on this right so first of all we have heard since they came into power that they are going to streamline planning that they are going to make it faster to build things.

22:52They came in with a pledge to build 1.5 million homes in England in this parliament. So that's roughly 300 ,000 a year. They are so far behind on that. They're saying in the first year, it was only about something like 180 ,000 that were built. And this is to do with planning approval, still not happening. It's also about the ongoing skills shortage. And I still feel like the skills side of this is so fragmented. And yet we've got Skills England and all these plans to bring it together and have this one big plan for skills. But so far, that is still not happening. And we are, you know, years in.

23:27So and on top of that, what we are talking about now is if the fiscal rules aren't going to change, inevitably, and she wants to help vulnerable people. And I totally get the argument for helping vulnerable people with energy bills and those who need it most. I get that. Who's going to pay for it? It's probably going to be businesses again. There's going to be all the questions now about what taxes are going to go up in autumn. It's that cancer of uncertainty again in business where everyone now is going to be going, well, hang on a minute. Let's think about what do we really want to invest? Oh, they've loosened planning rules a bit.

24:04But do we really want to put money in there when we might get taxed again? You know, and again, you're thinking about the higher earners will be thinking, well, it's probably going to be us. Do we need to be thinking about how we structure our finances again in this country? So it's that uncertainty it creates because as things stand, what we're hearing again from, I feel, from Rachel Reeves is just defensive stuff. It's not it's never about proactive change for the better. It's always about just, well, we just need to put this fire out and help these people for now. And then, you know, we are going to make planning better.

24:36We are going to do these things. but it doesn't feel like there's really any signs of it in a tangible way for anyone yet. And like we said, it was 2024, that first budget. We're in the middle of, you know, 2026 and it doesn't feel like it's any better. Yeah, I mean, the thing that is frustrating when you listen both to Reeves and Starmer is they say one thing that is important and then they go on to exaggerate. And what I mean by that is they are right to say that reassuring lenders to the UK that the path for borrowing and debt is sustainable is important, right? But then they constantly say, right, and they then say, And that is the most important element of our growth plan.

25:33It is, you know, and they characterize it as the growth plan. Now, to be clear, it would be very, very, very hard to attract investment and grow, you know, without confidence in markets that the government's debt is under control. But that it is not it is a condition. It's a condition of growth. it is not in itself a growth plan right and it's the absence of a plan on top of that that is frustrating and then you know that just to go back to what we talked about in our last episode which was the chancellor's so-called new growth plan which he outlined in her maze lecture so i've been thinking more about the huge inadequacy of what she had to say about closer economic ties with the EU.

26:28Because as I say, it's all very well to say, you know, we will take EU rules in sectors of the British economy where those sectors want to follow EU rules. As I said in that episode, first of all, that does not guarantee that the EU will actually play ball and reduce the massive administrative burdens of trading with the EU in those sectors. But there's one other thing about all of this that causes me deep anxiety, which is quite rightly she does recognise that there are certain sectors like tech, like artificial intelligence, where right now the UK is benefiting from the fact that it is setting its own rules separate from the EU.

27:23and the thing that I think she will you know the thing that I think is going to cause major problems to the government as and when it actually gets into negotiation on this sort of partial rejoining of the European single market is I basically think the EU will tell us to piss off because the one thing they've been consistent about is they don't want what they call cherry picking right you know that you know broadly they have a view which is completely understandable that you either follow all the rules or you follow none of them. And I think the idea that somehow for chemicals where it might suit us to follow EU rules, they'll say yes.

28:01But on the other hand, while they see our tech sector gaining enormous independent competitive advantage from not following their rules, why on earth would the EU in those circumstances say to Britain, yeah, you can have this bit because, you know, the bit that you like, but you don't have to follow these other rules. It just it makes that's just not how the EU in its entire history has ever operated. It basically says it's all it's all the rules or none. So I think there's just a sort of staggering naivety here. Now, if, as I say, actually, all she was really saying was, you know, we are on a path to do what Sadiq Khan, the London mayor, wants to do, which is to see the Labour Party go into the next election with a pledge to rejoin the EU.

28:49OK, that would be different, you know, but there is no sign from either Starmer or Reeves that they are on a course to do that. You know, you have to take them at their word that they think they're in the process of negotiating better terms of trade with the EU. And so far, everything that I hear from them on this sounds to me to be naive and completely unrealistic. Yes. So then where does that leave us? because that you know so then they don't get the terms we want where does that leave us it leaves us saying we've got to do we've got to take our own fate into our hands which is goes back to the conversation we were just having about there are quite a lot of things we could do um to improve our growth rate i mean i was rather struck do you remember when we had mark warner on the program um you know the boss of faculty ai um and you know one of the things that he was talking about was if you gave tax breaks to those who were setting up businesses like the one he set up, it would encourage more of these high growth companies to be created.

29:54There would be a political cost because the government would have to admit it's giving tax breaks to people who may well end up being very wealthy. But, you know, he would argue. And I think there's quite a lot to this. that, you know, in terms of, again, a statement of intent that the government understands what you need to do to create growth. Because the thing that, you know, really this government doesn't, I think this whole, obviously, it really, really, really matters that any government does what it can to alleviate acute poverty. I mean, too many people are living in appalling housing conditions and are really struggling to pay the bills.

30:41All of this matters, right? But we could, as a country, do so much more for those people if we got the growth rate up, which then got tax revenues up. And it's, you know, I'm not arguing that those with more wealth and more income can't afford to pay more. But truthfully, that is not a bottomless purse. The bottomless purse is provided when you get the growth rate up. And the failure to do that, but that is, you know, this is now a national emergency, right? It's a national emergency to do what matters in that sense. But my worry is, if in order to like give tax breaks to tech firms And I absolutely hear the argument that we need to be at the forefront of this.

31:32We have the brains, the skills, but often they're not given the financial backing or, you know, as we've talked about lots, they get a company going and it gets bought by America and everything else. But you cannot neglect what a lot of this economy, particularly outside of London, is built on. And it's the traditional jobs in, you know, in the public sector. It's people working in shops. It's people working in factories. It's people, and I know manufacturing's not as big as services and all that. But you don't want to put so much tax burden on those businesses who employ young people, for example, that you then stop them from employing people because then they're going to, this is just going to put even more people out into the benefit system.

32:18You know, when I go to the food bank near here that I work with, it is working poor people, but none of them are working in tech. They're all working in, you know, small supply chain manufacturers or they're working in the health care sector, in social services. They're working in shops in town. They're, you know, they're not working in the high tech area. And the danger is if we keep taxing the organisations that are employing those types of people, you're just going to push more people into poverty and into the benefit system. And so there has to be a coordinated plan about how we do this. How do you bring those people into the tech sector as well?