Capping energy prices may be our best tool to fight stagflation

The UK enters this moment in a weaker position than in 2022. Living standards have been squeezed for over a decade and still show the hallmarks of the Ukraine inflation spike. Cost-of-living pressures dominate public concern, and people remain acutely sensitive to the trauma of recent inflation. Plus, growth is stagnant, public debt is higher and unemployment is rising.  

Stagflation – a combination of high prices, low growth and high unemployment – defined the 1970s, and it could come to define this decade, unless policymakers act to stop inflation at source. Otherwise, stagflation will not just be economically damaging, it could be socially and politically destabilising. 

As long as we are heavily dependent on fossil fuels for our energy, there are no good options in a crisis like this. But the government can learn the lessons from the last energy shock and prevent a negative spiral. It must take action early, across three major fronts.

Key priorities for government

1. Cap energy prices - to break the inflationary cycle

The top priority should be to limit rising energy costs from feeding into the wider economy. The lesson from 2022 is clear: acting too late allows energy prices to cascade through the economy and embeds inflation, as firms and workers raise prices and wages. Wholesale price increases passed directly on to households and businesses will drive ‘second round inflation’. This would be very damaging in a UK context already defined by deteriorating living standards.   

Leaving energy costs to rise also risks the second-order response of increased interest rates. Interest rates increases, while ultimately effective, are a blunt and costly tool to stem the inflationary impact of a temporary supply-side shock. They would dampen already weak demand, lowering inflation by suppressing growth. This will increase mortgage costs, reduce investment and slow the transition to net zero. But of particular concern in the current UK context is the risk of unemployment – with youth unemployment already at 16 per cent, a blanket monetary response could have significant consequences for workers, notably for young people. 

There is a better alternative. Government should prepare to intervene directly to cap or stabilise energy prices before they spiral. This approach (put forward by IPPR during the 2022 crisis) could act as a circuit breaker – preventing temporary energy cost spikes from driving broader inflation in the first place. Australia and Spain have already started doing so in recent weeks.

Energy costs are a direct input into the consumer price index (CPI) and a foundational cost for businesses. If prices are capped, inflation will not spike as high, and the Bank of England will be able to set interest rates lower. 

Such a cap will only work if the energy shock is temporary, since the government cannot subsidise bills into the long term. Nor will it avoid an increase in inflation entirely. But it is the most powerful lever available to prevent an energy shock from cascading through the system.

The fiscal case is also compelling. Consider that every percentage point on inflation pushes up the cost of servicing our inflation-linked debt by £10 billion by 2029/30, and every one percentage point move in interest rates pushes government borrowing up by between £8 and £12 billion. An inflationary spiral would reduce government’s ability to fund public services and capping energy costs could limit this. 

Timing is critical. The experience of 2022 shows that acting too late allows energy prices to embed across the economy, making inflation harder and more costly to contain. The government should be ready and willing to act if and when energy prices are increasing to a higher level – and the energy crisis goes on for longer, risking an inflationary spiral. 

Evidence to support price caps’ effectiveness

International evidence supports this approach. During the last energy crisis, several European countries intervened directly in energy markets. Spain, Portugal and France acted early after the price shock in 2022, more effectively limiting energy price increases, and demonstrating how such an approach can contain inflation and protect growth. The UK and Germany acted late, and thus saw fewer inflation benefits. Germany brought a critical innovation, though: it subsidised only 80 per cent of households’ prior or forecast consumption, capping prices while still encouraging people to use less energy. 

More recent analysis, including from the IMF’s chief economist, suggests such interventions were effective in reducing headline inflation and limiting wider economic damage. In the UK Office of Budget Responsibility has already recognised that universal interventions to cap energy prices can limit the impact on inflation – its 2026 inflation forecast was lower in response to energy price support announced in the autumn 2025 budget.

How to pay for it?

Such an intervention would carry a significant upfront cost, potentially as much as £20 billion, depending on the duration and severity of the crisis - a forthcoming IPPR paper will set out detailed scenarios and estimates. If this was paid for exclusively via borrowing, for which costs are currently high, the risk of an adverse bond market reaction is a real concern. However, if the policy were well designed and communicated, this intervention would lower inflation and therefore lower borrowing costs compared to a ‘no-intervention’ scenario. Our forthcoming paper will estimate the magnitude of these effects.

Markets will need to be confident that the intervention is temporary, targeted at a specific shock, and part of a coherent macroeconomic strategy.

This can be achieved by:

• Clearly communicating that measures are time-limited and contingent on energy prices
• Coordinating closely with the Bank of England to demonstrate how it would assess the disinflationary impact of price caps
• Avoiding permanent, unfunded fiscal loosening alongside the intervention
• Highlighting that, unlike in 2022, fiscal loosening from this intervention would come at a time of low domestic inflationary pressures: unemployment is elevated and the labour market is loosening. 

Alongside borrowing, the government could use temporary tax increases to fund part of the intervention. The exact mix of borrowing and tax will depend on the size and duration of the shock - our forthcoming piece will discuss the scenarios and in greater detail. However targeted tax measures on those most able to contribute, plus the potential of temporary broad-based tax rises should be scoped and considered by government in the course of their preparations.  

2. Show households whose side you are on

Even if prices remain only briefly at current levels  and then fall rapidly over the next months (prior to the July price cap ending), the government should take action to demonstrate that it is acting in the interests of households and implement some targeted policies to reduce energy bills. Public confidence matters – particularly when cost-of-living pressures are already the dominant concern for voters.

There are already encouraging signs of government action. The PM recently calling out any companies looking to ‘rip-off’ consumers and profit from an oncoming crisis was welcome, as was the Chancellor’s warning to petrol retailers. Profiteering might not be the root cause of the issue, but action to prevent it sends an important behavioural signal to companies to not make rising prices worse. Regulators must proactively monitor profits across the energy system – particularly in trading – to prevent excess gains being extracted during periods of volatility. The targeted scheme for households reliant on heating oil and expanding the Warm Homes Discount were also practical responses. However, they can be complemented by further measures.

Targeted measures for the government to consider include: 

• Increase the ‘warm homes discount’ to all people on means-tested benefits and pension credit. Currently people receive a one-off £150 payment in winter – an additional summer payment would help with bills now (costing £ 1.5bn for each additional £150 payment).
• Widen access to low-cost finance for home energy improvements, including expanding loans for people to access solar panels. To reach 800,000 homes it would cost around £5bn (which could be taken from the funding already committed to the Warm Homes Plan).
• Energy bill debt forgiveness will immediately help some of the most vulnerable still dealing with the consequences of bill rises post-Ukraine (at a one-off cost of £5bn).
• Shifting ‘policy costs’ from energy bills into general taxation will reduce bills by about £40 and make electricity more affordable compared to gas – this will also help people reduce gas use (costing £1.2bn).
• Action to enable cheaper food prices – by forcing supermarkets to stock non-brand items, especially in smaller ‘convenience’ supermarkets; and ensuring discounts are available to everyone, not just members (costing nothing). 

These measures will not be sufficient if the energy shock is as significant as many fear. However, in a less severe situation they will be essential to protect vulnerable households and maintain public trust.

3. Accelerate the transition away from fossil fuels

Finally, the government must recognise that energy shocks are no longer rare events. In a world of heightened geopolitical instability, reliance on imported fossil fuels represents a persistent economic vulnerability. 

Some progress has been made. Gas consumption has fallen, and the expansion of renewable energy means gas will set electricity prices less frequently. But gas remains the dominant fuel for home heating and transport still overwhelmingly relies on petrol and diesel. 

Reducing this exposure must now be treated as an urgent economic priority.

Accelerating the rollout of rooftop solar offers one of the most immediate opportunities. Even at current prices, solar panels can save households hundreds of pounds per year, with relatively short payback periods. With the right policy support – including zero-interest loans and bulk procurement to reduce costs – uptake (and savings) could be rapidly scaled.

Similarly, supporting the transition to electric vehicles can reduce exposure to volatile fuel prices while complementing the expansion of domestic renewable generation.