Britain's stubborn inflation is decades in the making

New Statesman​

21-05-2025

Photo by Jordan Pettitt -This morning's inflation figures contained a nasty surprise. The consumer price index (CPI) was 3.5 per cent higher than last year in April, above the consensus of 3.3 per cent predicted by economists and financial markets. Earlier this month the Bank of England predicted inflation would peak at 3.5 per cent in the third quarter of this year; that peak has arrived already. The biggest contributor to the jump was energy bills – gas prices rose 7.5 per cent – but the second-biggest rise was water bills, which rose 26.1 per cent, the steepest rise since privatisation.
At Prime Minister's Questions this afternoon, Keir Starmer and Kemi Badenoch traded lines about whose fault the resurgence was, but the fact that water bills made such a significant contribution is a reminder that when your government makes a terrible decision, you pay for it repeatedly.
The public is now paying for the decision to privatise England's water and sewage services in at least three different ways, through both monetary policy and fiscal policy. Firstly, there is the direct cost of higher water bills. The point of privatisation was to keep bills low, and this was one of the main duties of the regulator, Ofwat. However, other countries (such as the Netherlands and Poland) have achieved lower bills for water supply without privatisation. Those countries have also invested in their water infrastructure, while the UK hasn't, and the environmental fallout of this negligence is the reason bills are now rising so steeply here.
But this is not the only way in which you pay for that decision because, as we have seen today, when you and everyone else is paying more for water, this contributes to higher inflation. The Bank of England has one tool to address this: interest rates. By raising its base rate, the Bank can increase the cost of your debts (or, for the more fortunate, the return on your savings) in order to force (or cajole) you into spending less on other things. So you pay a second time, through your mortgage, your car finance, or your credit card bill.
The payments do not stop there, however, because the bad decision will also have a fiscal impact. It introduces new costs to the government – which may have to rescue a failing water company, or provide investment in infrastructure, or to otherwise compensate for the consequences of the decision. To pay for this, the government might raise taxes and take money from you directly. But even if it tries to avoid doing so, you will still pay, because inflation will remain higher and more volatile, and the value of government debt will be eroded. Because government debt is a significant component of your pension fund, this means the bill is once more handed to your future self, to pay for the third or possibly the fourth time.
Where water bills are concerned, it seems pretty unlikely that a new and much more profitable type of water is going to be invented. There is not really a prospect that the profits of the water industry are going to rise to meet the need for investment, and its costs continue to steepen. (To take one example, Southern Water, which announced its annual results this morning, paid its CEO, Lawrence Gosden, £764,200 in 2023/24, a 78.7 per cent rise on the previous year's pay.) The largest provider, Thames Water, is currently the subject of 31 criminal investigations, which will also add to its costs. So, the money for investment will have to come from higher bills, higher interest rates or higher taxes, or possibly all three.
Jagjit Chadha, professor of economics at Cambridge University, says the same principle applies to other areas of the economy, such as railways and roads, which, like water, interact with production and consumption across the economy. The poor management of public assets means that 'the supply side of the economy is restricted', he told me, 'and that means every time a shock comes along, we end up with more persistent and elevated inflation than would otherwise be the case'. The cost-push inflation we see in water bills today is 'a signal of poor economic management since we went headlong into privatisation without appropriate regulations in place, which left us open to these risks that are ultimately borne by the household'.
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The current consensus is that inflation is not on the rise again as it was in 2022 – this month's monetary policy report predicts that having peaked in the autumn it will 'fall back thereafter', which sounds relaxing. A less optimistic model, released this week by the National Institute of Social and Economic Research, suggests it will continue to rise, reaching 5.3 per cent in March 2026. The prospect of trade war (and actual war) make the outlook even more uncertain; an economy with a constrained supply side cannot respond easily to such shocks.
Labour's answer is that we will be rescued from this predicament by economic growth, which Chadha agrees would be great – if it appears. 'You can't conjure it up. It's a get-out-of-jail card, but it's not one you can buy, like in Monopoly. You can wait for it, but you can't bank on it.'
[See also: No one understands Rachel Reeves's fiscal rules]
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