LONDON — Gone are days when British consumers could brighten their mood by indulging in a bit of retail therapy. These days, as soaring prices for many products and services continue to hit eye-watering levels and take a big bite out of people’s finances, shopping – particularly for groceries – is instead a depressing experience.
To be sure, the economic aftershocks of the pandemic and Russia’s invasion of Ukraine have for more than a year sent cost-of-living expenses into the stratosphere in nearly all developed countries. But while inflation is easing fairly quickly in most richer countries, including those in the European Union and the United States, it’s remained stubbornly high in the United Kingdom in comparison.
And while Brexit, Britain’s 2016 decision to leave the EU and its single market, may not be the biggest or only reason for inflation’s persistence in the U.K., many economists say it’s made a bad situation worse. “It’s clearly part of the problem,” says Jonathan Portes, an economics professor at King’s College London. “Because of Brexit, prices are higher than they would have been.”
Inflation’s unrelenting tenacious grip on the economy threatens to accelerate diminishing voter support for the Tories under the leadership of Conservative Prime Minister Rishi Sunak, who has pledged to bring the rate down to around 5%.
Government figures released in late May showed that inflation in Britain was 8.7% this year, as of the end of April. That was down from 10.1% in March, but it was higher than the 8.3% that markets had predicted. And core inflation, which strips out volatile energy and food prices and is considered a harbinger of where prices are headed, jumped to 6.8% from 6.2%.
“Inflation is riding on longer-term trends in Britain and Brexit made things worse,” explains Ethan Ilzetzki, an associate professor of economics at the London School of Economics.
The U.K., for instance, is more reliant on natural gas for home heating and electricity generation than most of Europe and fewer of its homes are properly insulated, so it was hit harder when the war in Ukraine sent energy prices skyrocketing. Moreover, while productivity has slowed throughout the developed world since 2008, “it’s been particularly bad in the U.K., and there’s not a good explanation for why,” Ilzetzki says. Low productivity dampens economic growth, so some economists believe it provides a fertile climate for inflation.
In a BBC interview last week, former U.S. Treasury Secretary Lawrence Summers called Brexit a “historic economic error” that made the U.K. less competitive, weakened the pound and placed limits on imports and the labor supply – “all of which contributed to higher inflation.”
Ilzetzki, like Summers, also pointed to worker shortages as a problem. Britain, he says, has hundreds of thousands of workers still sidelined by COVID-19-related ailments. “Other countries can handle this fluctuation in the labor supply through migrants, but Brexit cut migration from the EU.” Portes says that while “it’s difficult to dispute that (premise), it’s hard to see it in the data,” because overall immigration is higher.
But Ilzetzki counters that while immigration has rebounded somewhat because of an influx from non-EU countries, it’s mainly at the low-skills end, and Portes admits that “you can make the argument that the U.K. economy is not as flexible as it used to be.”
Last month, the Bank of England hiked its main interest rate for the twelfth time to 4.5%. Investment banks now predict that the rate will hit 5% to 5.25% by September. The upshot is that Britons will face higher mortgage and consumer loan rates while the chance of a recession increases.
Nevertheless, Ilzetzki and Portes both argue that the case for continuing rate hikes isn’t a slam dunk.
Central banks raise rates to depress demand in hopes of avoiding a wage-price spiral, which can cause inflation expectations to become embedded, thus creating an endless cycle of rising wages and prices. However, Portes says, “there’s very little evidence of a wage-price spiral.” Wages in Britain are not keeping up with inflation, and consumer expectations of inflation have eased. “Consumer expectations on inflation still indicate a short-term problem,” Ilzetzki says.
Accordingly, Portes says, “there’s a legitimate argument that the risk of overdoing rate increases outweighs the risk of wait and see.” But the lack of progress on inflation nevertheless places political pressure on the central bank to act, he says, regardless of what the data says. The bank, “is not immune from political criticism.”
In January, when inflation was at 10.1%, Sunak vowed to halve it. Given that governments have few tools with which to fight inflation, it was a somewhat risky bet. However, back then the markets were predicting that inflation would fall faster than it has. “I suspect he is regretting (that pledge) because it’s proved a more difficult task than he envisioned,” says Tim Bale, a professor of politics at Queen Mary University of London.
The next general election is likely around a year and a half away. But, even if inflation has been whipped by then, Bale says, the perception that it was mishandled by the government will likely be set in the public mind. And once the inflation rate returns to a normal level, most prices won’t fall – they just won’t increase so quickly. That can leave real wages and salaries lagging prices, making voters feel poorer.
“Real wages are important,” but the government can’t make the case for higher wages if it wants to tamp down inflation, Bale says. “They’re damned if they do; damned if they don’t.”