Europe's Policymakers Grapple with Soaring Natural Gas Prices

As surging natural gas prices stoke inflation throughout Europe, policymakers are responding to both reduce the economic damage of high energy prices and clamp down on blistering inflation rates. It’s a challenging balance to strike, and the arrival of cooler weather won’t make the task any easier.

UK prime minister Liz Truss has come to power in an environment that would challenge even the most adept policymaker. Surging natural gas prices are pushing inflation to levels not seen in generations, punishing households. Last month’s inflation forecasts from the Bank of England (BoE) show prices rising more than 13% this year and staying above target for almost two years. Forecasts also show the economy falling into recession in the coming months as real, or inflation-adjusted, incomes collapse.

UK Price Caps Should Put Some Dent in Inflation

Against that backdrop, Truss announced a price cap on natural gas to shelter households from the 80% increase scheduled for next month and more price resets slated for January and April 2023. The government will most likely borrow to bridge the gap between market prices and the capped price, with even conservative estimates near £200 million.

What are the macroeconomic and monetary policy implications of such a large program?

We expect the cap to make a dent in inflation. With no action, UK inflation could easily have topped 15% this year. With the cap, we expect inflation to end the year around 10%, though that’s still much too high. Inflation will also likely fall much more quickly in 2023 than it would have; we forecast a 3.0% rate in December 2023. For 2024 and beyond, much depends on European natural gas prices and whether the price cap is extended—both are impossible to forecast this far in advance.