A real tough choice: freeze the cap, and most of it pays for itself

Although Andy Burnham has claimed that he is, in effect, match fit to make tough choices, the truth is that so far he has made none. However, before too long he will be confronting them thick and fast. The first will come with the budget in October, when the Prime Minister and his Chancellor will have to grapple with significantly less fiscal headroom thanks to changed conditioning assumptions in the OBR's economic model. My sense is that the giveaways he will inevitably want to take credit for will have to be financed with tax increases, because the tough choice to cut welfare spending is one he will not confront.

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The other tough choice, and the one I want to focus on here, will come later in November when the energy price cap for the three months from January next year will be fixed. Based on where wholesale gas prices are now, and assuming they stay there, the cap could be going up by slightly more than 20%, and that is on top of the cumulative 17% increase over the last six months.

The gas price, not the oil price

Interestingly, it is the gas price that is causing the biggest inflation headache in the UK now, and not the oil price. To put this into context, oil prices averaged $80 a barrel between 2010 and 2019 and have so far averaged $95 in 2026, despite the industry going through what the IEA has called the greatest energy security threat in history. That $15 premium, whilst uncomfortable, is not unbearable, whereas the doubling of the natural gas price in the UK since the start of July, to very nearly 200p per therm, is quickly becoming very uncomfortable indeed.

Cornwall InsightEnergy Bills Forecast to Hit Three-Year HighEnergy bills are forecast to rise by 4% from October according to Cornwall Insight's final forecast for the price cap.

Our energy bills remain tied to events thousands of miles away

Dr Craig Lowrey, Principal ConsultantEnergy Bills Forecast to Hit Three-Year Highcornwall-insight.com · 19 Aug 2026 ↗

For a leader who highlighted, on a recent tour of the UK, a singular and primary focus on alleviating the cost of living, this is not something that he can duck. However, one would be forgiven for thinking that he is between a rock and a hard place, given that his predecessor has already maxed out the credit card and significantly increased tax to pay for it, giving Mr Burnham only a very limited set of options. Having said that, fortunately there may be a way for him to significantly soften the blow of this energy price impact without increasing taxes or cutting spending to pay for it, albeit that it is not obvious and might cut across some obtuse socialist ideology. It might also confront resistance from his mate next door and from the Treasury, based on the "not invented here" principle, but it could help to solve a big problem for him if gas prices remain where they are now. Here is how.

Yields are a rounding error. Inflation is not.

Contrary to consensus thinking on gilt yields and funding costs, although it is true that higher ten-year yields, if maintained, will in the long term increase the debt interest burden, the impact of higher conventional yields in the short term is pretty minimal: basically a rounding error in terms of total managed spending of £1.4trn in 26/27, and total debt interest costs of £111bn. Having said that, interest costs are materially sensitive to inflation outcomes because of their impact on index-linked coupons and principal. The outstanding book of index-linked government debt is just under £690bn, or about a quarter of the total book of debt. In summary, if inflation increases by a certain percentage, an index-linked bond's principal value increases by a corresponding amount. Although the fixed coupon percentage does not change, because it is calculated as a percentage of the upwardly adjusted principal, it also increases. This means that, in round terms, if there is a 1% increase in UK inflation over twelve months, the increased cost of servicing the book of index-linked debt is just under £7bn. Consequently, if via some mechanism the government could intervene to lower recorded inflation (CPI), then there would be a corresponding saving in the index-linked debt interest bill, amongst other savings, and hey presto, a saving without cutting welfare.

What happens if he does nothing

But before outlining what the Prime Minister could do, I should explain what is likely to happen without any intervention. The energy price cap is fixed four times a year and it is one of the biggest single administered prices in the CPI basket. If gas prices remain where they are now until November, then it is likely that this part of the basket will increase by just over 20% for the period January through to March, which will, with slightly higher food prices, push headline inflation close to about 4% in January. This in turn, being about 1% above where inflation is now, will increase index-linked debt funding costs by about £7bn if maintained for a full twelve months, which I think is unlikely, but it helps with the maths.

So, without any intervention, here is another government spending increase Mr Burnham and Mr Healey will not have bargained for. And of course, higher headline inflation also directly increases other expenditure items the government has to fund.

Freeze it

However, the action that could provide significant relief here, both for consumers and for the government, is if Mr Burnham decided to freeze the energy price cap at its current level in November. That would have a significantly positive impact on headline inflation, but it would come at a cost as well.

First to the cost. A 20% increase in the cap will lead to a £350 increase if maintained for a full year. Assuming all 29 million households in the UK are gas consumers, which is clearly not true but helps with the maths, that leads to an increase in energy costs for all households of £10.15bn, and the same full-year cost to the government if it steps in to prevent the increase. The £10bn would be paid to the gas industry to compensate them for the difference between the retail and the wholesale price. Clearly it cannot afford that, but it is not the whole picture, because if the government intervenes the CPI does not get pushed up in January. If we assume that CPI as a result is 1% lower for a full year because of the intervention, and it may not be as much as this, but the maths is easier, that will save £7bn in index-linked interest costs. So the net cost is a much more manageable £3bn, and probably less given other savings the government would benefit from as a result of lower inflation. A lower inflation rate would of course also deliver other benefits to business and households in the form of lower interest rates, with the MPC not under pressure to hike, and lower mortgage rates.

So, if Mr Burnham had the minerals to do this, and Liz Truss did back in 2022, he not only really does make a tough decision but also matches the cost-of-living rhetoric. And maybe if normality returns to energy markets by the spring, the whole thing goes away and his political capital is increased. The potential blocker, though, is not insubstantial for those in the Labour party wedded to socialist principles rather than to pragmatism, because a scheme like this provides relief to all households. It is quick and very cheap to implement: the government only has to write a few cheques to a few energy suppliers. It is not means tested, and so the government ends up giving relief to richer households. Some in the party could not swallow this, placing principle above pragmatism despite the benefit to all and to the wider economy.

Will it happen?

When this idea was put in front of Rachel Reeves, political resistance meant it was not adopted, and the same self-serving nonsense might again prevent what to me looks like a simple and eminently sensible idea from being implemented. We will see if Burnham and Healey are more pragmatic than their predecessors, but if they do nothing, the economic hole that is currently being dug for them will get deeper and deeper by the day.