The post-pandemic inflation burst has subsided in many parts of the developed world. However, Britain still suffers from the highest rate of price increases among the Group of Seven economies. Bank of England responded by raising interest rates at the fastest pace in decades, worsening an already dire cost of living crisis. How did we get here? And is there any hope for relief?
As economies recovered from the coronavirus outbreak, inflation spiked as people spent the money they had saved during the lockdowns. Companies struggled to keep up with the surge in demand. Energy prices also soared. In the UK the Consumer Prices Index reached a peak of 11.1% in October, and then fell to 8.7% in the following month. This exceeded the expectations of both economists and Bank of England by a third straight month. Inflation expectations are also moving well above the BOE’s 2% inflation target. The core rate, which excludes volatile food and energy prices, has also increased unexpectedly. In April, inflation in the US was 4.9% and in the Eurozone it was 7%.
The UK is unique. The UK is in a unique situation. It suffers from a labor shortage like the US while also dealing with an energy crisis that has affected all of Europe. BOE faces a difficult task, made more difficult by the UK’s exit from the EU as well as a system that protects consumers from rising energy costs. BOE Governor Andrew Bailey stated that the price cap, which limits the cost per kilowatt-hour of energy, has slowed down the rate at which lower energy prices are reflected in household bills. Some economists claim that this is the main reason for the disparity between UK inflation and the rates of other countries. They also predict the gap to begin narrowing in July. Second, the tight job market is a major factor. The tight jobs market tends to result in higher wages which, in turn, pushes businesses to increase prices to offset the additional cost of their wage costs. There were at one time more vacancies in Britain than there were unemployed, partly due to the pandemic that caused more than 500,000 people to leave the workforce.
The BOE is increasing interest rates on mortgages to control inflation. Since Britons refinance more often than their counterparts in the US or continental Europe, many households are exposed to higher rates. Between May and 2023, 1.3 million homeowners will refinance their fixed-rate mortgages at a higher rate. The cost of borrowing is increasing for both businesses and consumers. The wages are not keeping up with the prices, which is causing the most severe cost of living crisis ever. The working-age population is often the hardest hit, as older generations are more likely to own their homes outright and to receive pension payments that are linked to inflation. The prospect of further rate increases and the persistent inflation are a major headache for Prime Minister Rishi Sunderak’s Conservative Government, which is widely predicted to contest another election in 2024.
Economists believe Brexit is also to blame for the inflation problems. London School of Economics research suggests that Brexit was responsible for a third of the UK food price increase between March 2023 and the end of 2019. This is because the extra border costs increased grocery prices by PS7 billion ($8.8billion). BOE member Catherine Mann, who is on the monetary policy committee warned that newly erected barriers to trade made the UK “unique.” BOE chief economist Huw Pill stated in February the impact of Brexit on supply and productivity increased the risk of an overheating economy.
A less productive workforce produces fewer products and services at a higher price per unit. This limits the ability of an economy to grow without instigating inflation. The Brexit vote is not solely responsible for Britain’s productivity issues. The UK’s productivity growth was the second lowest among industrialized nations in the Group of Seven between 2009 and 2019. The lack of investment by government and business has been blamed since 2008 for the low productivity growth.
Recent economic data and the global commodity market offer a glimmer of hope to the BOE. The UK’s jobs market is showing clear signs of cooling and a reduction in the upward pressure on salaries. Food inflation is only able to defy gravity so long, say experts, after the sharp declines in global agricultural commodities markets. Some economists also believe that hot spots in April’s stronger-than-expected goods inflation will prove to be a blip.
It’s unclear. The US Federal Reserve may be moving towards a pause on interest rate increases. However, recent strong UK prices data suggest that the BOE will have to continue raising rates. Investors expect rate increases to continue throughout the summer, and are leaning towards a bank rate peak of 5.5% at the end of the calendar year. This is a point higher than current levels. Another factor that makes it difficult to decide when the BOE will stop raising rates is the longer delay in the impact of the monetary policy, largely due to changes in the UK mortgage market over the past decades. Only a third (or less) of previous rate hikes have been reflected in the economy, according to BOE.