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Thursday, Oct 29, 2026

Rishi’s nightmare: will inflation crush the recovery?

Rishi’s nightmare: will inflation crush the recovery?

At first, it seems to make no sense. Britain is in the middle of the worst economic crash in recorded history, with a Chancellor who is famously keen on low taxes, spending control and sound money. But Rishi Sunak this week presented a Budget that seems inspired, in parts, by Labour’s last manifesto.
Debt surging to £2.8 trillion. Public spending up by a quarter in a year. And taxes: soon going up. Corporation tax, freezes to the personal tax threshold.

The explanation most Tories comfort themselves with is that Sunak wants to explain to a high-spending Prime Minister that today’s cash splurge is tomorrow’s tax rise. But in truth, Sunak is motivated by something else. It’s not dreams of fiscal sanity that are driving him towards austerity, but nightmares about a far more immediate concern: an inflation resurgence that could crush Britain’s economic recovery and follow the pandemic with a financial crisis. If so, he worries he would have no reserve parachutes left to pull.

Worrying about inflation might seem strange, even quaint, in a country that has known barely any for almost a generation. When Sunak was born, in 1980, inflation was about 17 per cent — with interest rates and government borrowing costs around the same level. This was the great Thatcher--Reagan mission: to tame inflation, restore faith in money and protect savers. It worked. By the turn of the century, rates were on the floor. Central banks are now tasked with a mission: to use whatever tools are needed to keep inflation stable.

Today’s trifecta of low gilt rates, interest rates and inflation means that no one bats an eyelid as Sunak borrows roughly £1 billion a day, or announces giveaways amounting to £65 billion additional spending. £400 million for the arts? Certainly. Furlough extended until September? It’s on the house. Not so long ago, fiscal conservatism was the pillar of the Tory platform. Now a magic money tree grows in the garden of the Bank of England and conservatives are willing to pick from it. Spend now, worry later. If at all.

The Chancellor’s concern — which he doesn’t talk much about in public, though he did reference it in this week’s Budget — is about what happens if the magic stops and this agreeable set of circumstances changes, even slightly. The government now pays just 0.8 per cent on money it borrows. A small uptick of 1 percentage point— still amazingly low by historical standards — would cost billions. And Sunak has been asking his officials to calculate just how much. The answers are — to him, at least — terrifying.

The Office for Budget Responsibility recently estimated the impact of a percentage point rise: in inflation, interest rates and UK government borrowing costs. It was £25 billion: the equivalent of half the school budget, and almost twice England’s policing budget. A two-point rise doubles that. These numbers move up and down, but sooner or later, you’re starting to talk about real money. These payments won’t translate to people feeling better off: ‘That money wouldn’t pay for more nurses or hospitals,’ says one senior figure in the Tory party. ‘It would pay for what we’ve already bought.’ He could be one percentage point away from having to make painful choices quickly.

The question is what could bring this about. Or who. Joe Biden may be far preferable to Donald Trump for most Tories, but his economic agenda is starting to cause real concern in Downing Street. America’s new President is getting ready for the mother of all spending sprees to revive his economy after the pandemic. He plans a $1.9 trillion stimulus package: that is to say, he’s all set to pump more than double as much money into the economy as Barack Obama did after the financial crash.

The worry is that when Biden pours all this free vodka into a post--pandemic party, things could get out of control pretty quickly. Larry Summers, who served as Treasury Secretary under Bill Clinton and as an adviser to Barack Obama, is already warning of inflation danger. An ‘enormous risk we are running’, he said recently: even he is worried by the Biden splurge. ‘We’re gonna set ourselves up for inflation. And then we’re gonna either have inflation or we’re gonna have a collision between fiscal and monetary policy to contain inflation of a kind that usually doesn’t end well.’

Fears around the value of the dollar are starting to be reflected in the market: the price of gold, widely seen as a hedge against inflation, surged 24 per cent last year, its biggest advance in a decade. The stock market has recently been unable to decide between whether it expects a pandemic rebound (in which case shares soar) or overheat followed by inflation and a crash (in which case shares plunge).

Even George Osborne is warning about American-driven inflation ‘derailing’ Boris Johnson’s government. It seems crazy to even talk about this when the normal conditions for rising inflation — tight job markets and expectations of rising prices — are glaringly absent. But this is all about what comes next, and how hard it might be to control.

Normally, inflation would be fought by raising interest rates: but that’s a tool that’s simply unaffordable right now, with the UK set to borrow hundreds of billions more in the coming years. Like Sunak, Biden plans tax rises to accompany his spending. But some say there’s a big difference in Sunak’s case. ‘He isn’t falling in behind Joe Biden,’ says one senior government official, responding to claims that the Chancellor wants to use the President’s expected tax hike plans to force through a British tax raid. ‘He’s trying to make the UK economy resilient to decisions made elsewhere.’ It’s a polite way of saying that Sunak wants to make Britain Biden-proof.

Many economists argue an uptick in inflation wouldn’t be such a bad thing. A rise to 2 or 3 per cent is manageable, and may even help inflate away our debt. But once inflation is unleashed, it can be hard to control. This was Friedrich Hayek’s warning to the Mont Pelerin Society Conference in 1969. ‘If the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished.’

Last week Andy Haldane, chief economist at the Bank of England, published a speech, ‘Tiger by the Tail’, named after Hayek’s metaphor. The conditions that killed off inflation, he said, are disappearing. Many of the de-flationary forces from decades past have shifted or vanished. The impact of China’s entry into the world economy — dramatically reducing the cost of goods and labour — cannot be repeated. The era of lockdowns has forced global trade into reverse — we don’t know if it will come roaring back. There’s no playbook for when you artificially suppress an economy, creating a staggering amount of pent-up demand. Haldane didn’t predict an imminent inflationary surge — no serious economist is doing so. But he earmarked it as a threat to the UK recovery.

Boris Johnson, for one, isn’t worried. He told this magazine just over a year ago that austerity had been a mistake. The world over, Johnson sees big government spenders getting away with it — the markets want to lend and at low rates — so why worry? The hawkish Tories, he thinks, were proven wrong after the financial crash.

Perhaps he’s right. But regardless of whose instincts turn out to be correct, there’s no doubting the harm that even a small uptick in rates could inflict on the UK economy. It’s not much of an exaggeration to say that Johnson’s premiership is now staked on a gamble that low rates will last.

This may explain his approach to lockdown. While Britain now has less Covid than the average developed country, our lockdown is one of the most stringent in the world — and this has major costs. Weekly figures from the OECD, analysed by The Spectator, show that as of last week, the UK was suffering one of the highest levels of economic damage in the developed world, compared with the year before. Irrespective of the vaccine rollout, this may be Britain’s fate for weeks to come.

However keen Sunak may be to kickstart the economy again, he will have to play with the hand he is dealt by No. 10. It’s not just the tax commitments from the last Tory manifesto — protecting income tax, national insurance and VAT — but the pledge to move away from spending cuts and austerity affecting public services. Nothing can be slashed, even in areas where there’s appetite for reform. This gives the Chancellor very little room to manoeuvre.

When there was talk about abolishing the pensions triple-lock last year, many Tories thought that it might be the moment to move away from a pledge that’s widely regarded as an unaffordable vote bribe. ‘Everyone was on board,’ says a Tory insider. ‘We could have tackled a key source of intergenerational unfairness.’ It’s thought that the Prime Minister vetoed this. ‘He is Reaganite in one way only,’ says one minister. ‘He thinks the deficit is big enough to look after itself.’

In the meantime, the spending projects keep popping up like paper buds on the magic money tree, including £100 billion worth of infrastructure manifested by last year’s spending review. The Chancellor’s Budget has to account for all this, not to mention for his party’s new appetite for huge increases in spending and debt. The tax rises are his effort to try to limit government’s exposure to the return of the inflation tiger, but there are risks here too. A heavy tax burden — now estimated to be at its highest in 70 years — will dampen economic growth.

Things might yet be fine. Hawks, after all, have been warning about inflation’s return for years. Sunak’s tigers may be imaginary, and he could soon be presiding over an economic boom with a vaccinated country roaring back to work. But if a tiger does appear, his nightmares could quickly become reality.
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