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Inflation and wage pressures will squeeze already stretched public services

Line chart of Unemployment rate (%) showing UK unemployment has fallen to its lowest level since 1974

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Good morning. UK inflation has hit 9 per cent, the highest level in more than 40 years and almost double the rate the Bank of England expected six months ago. Today we analyse the challenges this poses for ministers, and ponder whether the Conservatives might be coming around to a windfall tax. Get in touch at the email address below.

Inside Politics is edited by Georgina Quach. Follow Stephen on Twitter @stephenkb and please send gossip, thoughts and feedback to insidepolitics@ft.com.

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The wages story is a public services story, too

Good news! UK unemployment has fallen to its lowest level since 1974. Bad news! What did we have in 1974? Answer: runaway inflation, stagnant growth and a mediocre Labour party winning a general election by default.

That historical fact is what spooks Conservative MPs and cheers Labour MPs. The pressure on households is one reason why Sir Keir Starmer enjoys a reliable opinion poll lead over Boris Johnson. More importantly, it has painful, long-lasting consequences for households today. As my colleagues Delphine Strauss and Chris Giles point out, Britain is contending with the same shock to energy prices as other European countries, but it also has a labour market more like that of the US, with widespread worker shortages fuelling wage pressures.

The problem this creates for the Tory party is this: if prices are rising but wages aren’t, then all voters will be miserable and this is bad for the government. But if prices and wages are rising, this creates specific pressures on the public sector, which will struggle to fill vacancies.

If you take bonuses into account, total pay is still outpacing inflation, according to the Office for National Statistics’ figures for the three months to March. But compared with the private sector, wages in the public sector are languishing behind. Nominal total pay rose 10.7 per cent year on year in finance and business services, but just 1.4 per cent — equivalent to a big real terms fall — in the public sector.

Line chart of YoY change in CPI index (%) showing UK consumer price inflation hits its highest level in 40 years

Inflation is, obviously, a direct political problem for the government. But it is also an indirect one, because of the pressures it creates on the public services. Employees in the public sector will go elsewhere, further deepening the pressures already being experienced by schools and hospitals.

As Laura McInerney, formerly editor of SchoolsWeek, explains here, the UK is already facing a shortage of teachers for many different reasons. Add rising private sector wages on top of that and you have real problems.

Starmer’s party has any number of deficiencies, but I think the most probable scenario after the next election is Labour in office. It is hard to see how the Conservatives can avoid fighting the next leadership contest against a backdrop of general inflation (which is bad for an incumbent government of any hue), or one in which the public services are under strain (which favours the Labour party whether it is in opposition or government).

Labour’s big break

The chancellor Rishi Sunak has, thus far, resisted Labour’s calls for a windfall tax on the energy companies, arguing that it could hamper investment in the North Sea at a time when the government wants to improve the UK’s energy security. How long can he keep it up?

There are good reasons to resist windfall taxes, but, as Chris Giles explains at greater length here, now may be a rare moment when a windfall tax is a good idea. Equally importantly from the government’s perspective, shadow chancellor Rachel Reeves and her colleagues have been making a lot of running calling for a windfall tax, so implementing one yourself deprives the opposition of a useful talking point.

On top of all that, the government may well want to exit from the energy price cap. Conservative ministers and MPs alike are prone to compare the cap to the exchange rate mechanism, the ill-fated attempt to peg sterling to the Deutsche mark, which the UK eventually was forced to painfully separate itself from.

You can see how the government could abandon the cap and use that as a pretext to introduce a windfall tax on the energy companies, which would free the Conservatives up to fund a series of measures to ease the pain of rising inflation. But whether the government ends up abandoning the price cap or not, it is highly likely that the Conservatives will end up embracing some kind of windfall tax. Tell us what you think by voting in our poll.

Poll asking if the government should impose a windfall tax on energy giants.

Now try this

This Vanity Fair piece on the future of Star Wars is fascinating: not so much for the titbits about forthcoming films and TV shows, but for Lucasfilm president Kathleen Kennedy’s reflections on what has worked, and what hasn’t, since Disney’s $4.1bn capture of George Lucas’ blockbuster franchise.

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