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Chancellor Rishi Sunak faces a “huge judgment call” over whether to borrow more or allow household budgets to be squeezed, new research suggests.
The Institute for Fiscal Studies (IFS) says the soaring cost of living and war in Ukraine present fresh challenges ahead of the Spring Statement.
Without extra protection, many households will struggle to keep up with bills, it suggests.
The cost of living recently hit a 30-year high.
Prices surged by 5.5% in the 12 months to January, up from 5.4% in December, due to rising energy, fuel and food prices.
Inflation, which measures how quickly the cost of living increases over time, is now rising faster than wages and is expected to climb above 7% this year.
As Vladimir Putin’s invasion of Ukraine pushes energy costs, fuel and other commodities even higher, the IFS says Chancellor Rishi Sunak faces three big decisions.
The first is whether to borrow billions more or allow household incomes to take a bigger hit than at any time since at least the financial crisis. The government has already increased borrowing in recent years to pay for Covid-related measures such as the furlough scheme.
Mr Sunak must also weigh whether to allow inflation to impose effective pay cuts on teachers, nurses and other public sector workers – or to spend less than anticipated on other parts of public services, if borrowing is not an option.
Public sector workers face an average pay cut of about £1,750 once inflation is taken into account, the IFS research says.
And as war in Ukraine continues, the chancellor will have to decide whether to allow defence spending to fall over the next three years, or to borrow to boost it.
“At the Spring Statement, Rishi Sunak has to make a huge judgment call,” IFS director Paul Johnson said.
“Will he do more to protect households from the effects of energy prices, which have risen even further in the last two weeks?
“If he doesn’t, then many on moderate incomes will face the biggest hit to their living standards since at least the financial crisis. If he does, then there will be another big hit to the public finances.”
He told the BBC’s Today programme that the chancellor will have to borrow “at least another £10bn just to cover half the blow from energy prices”.
Mr Johnson warned that rising energy costs look set to continue rather than be a short peak peak. “If energy prices are high for three-to-four years, it makes it much harder for the government to support people,” he said.
Rising inflation – which he warned could reach 8% or more this year – is hurting public sector workers.
Mr Johnson estimated the Treasury would have to find between £1,500-£2,000 per worker to make up the impact of inflation on pay. “They’ve already suffered big cuts,” he said.
The IFS suggests that if Mr Sunak wants to achieve the same level of protection for households’ budgets as he announced earlier this year, he will need to find an extra £12bn.
While the chancellor might have had little choice in spending billions to protect the economy during the extraordinary circumstances of the pandemic, Mr Johnson says the chancellor’s response to the cost of living crisis will reveal more about how he sees the government’s role in protecting consumers from external events.
The boss of energy regulator Ofgem, Jonathan Brearley, for example, has said that households are heading for an “almost inevitable” rise in energy bills in the autumn.
Spikes in wholesale gas prices, which were rising even before Russia’s invasion of Ukraine, will be passed on to consumers, he warned on Tuesday.
A Treasury spokesperson said the government was already providing more than £20bn to help people with the cost of living and would continue to monitor the economic impact of the conflict.
“Russia’s devastating invasion of Ukraine will have a huge impact on lives and livelihoods around the world and the effects will be felt across this country,” the spokesperson said.
“It is right that we do all we can to show solidarity with the people of Ukraine and work with our allies and partners to impose the most punishing sanctions to inflict maximum and lasting pain on Russia.”
The shadow chancellor, Labour MP Rachel Reeves, accused the government of allowing “the cost of living crisis to spiral out of control since September”.
She called on the chancellor to reconsider “unfair” National Insurance contributions, which are due to go up in April to fund social care in England and help the NHS recover after the pandemic.
The Labour party has proposed the introduction of a one-off “windfall” tax on oil and gas producers, which would then be used to cut energy costs for consumers.