As the Bank of England hikes interest rates to keep prices in check, the UK’s inflation rate remains worse than the EU’s. Here’s why.
The Bank of England has raised UK interest rates by a quarter of a percentage point to 4.5 per cent – the highest level since 2008.
It’s an attempt to lower the country’s inflation, which remains in the double digits, at 10.1 per cent as of March this year.
That’s more than five times the Bank of England’s 2 per cent inflation target and a higher rate than in any other major European economy. The EU’s average inflation rate stood at 8.3 per cent in March.
But both the UK and the EU have been hit hard by the COVID-19 pandemic as well as by the effects of Russia’s invasion of Ukraine… So, what is going on?
1. Soaring food prices
Food prices in the UK are rising at the fastest rate since 1977, partly fuelled by salad and vegetable shortages over the past few months in the UK.
Due to extreme weather affecting Spain and Morocco, the main suppliers of vegetables such as lettuce and tomatoes have been mostly to blame.
Shortages have also been exacerbated by high energy prices leading to farmers cutting down on crop yields and heavily relying on imports for certain foods, as explained in this separate fact-check by The Cube.
2. An inflexible labour market
According to the BBC, while most major economies have recovered from the labour shortages caused by the COVID-19 pandemic, the UK still has about 400,000 more people not working than in December 2019.
For Jacob Kirkegaard, an economist at the German Marshall Fund, this is due to two reasons.
“There is a very high level of regional income inequality across the UK. Living in London is more expensive than living in most of the rest of the country, making it quite difficult for people to move to places with more economic activity,” he told Euronews.
“So, you have increasing labour shortages in parts of the UK. Then, you’ve got a significant number of European citizens leaving the UK after Brexit. Even though non-EU immigration to the UK has increased, these workers may not possess the same level of skills.
“Overall, you have a less well-functioning labour market creating bottlenecks and the necessity for increasing wages, hence driving inflation”.
3. Brexit
According to experts like Kirkegaard, inflation is also directly correlated to the UK leaving the European Union.
“The breaking up of all the traditional trade flows that the UK had with the rest of Europe is significant. This is particularly important on issues like fresh food and other products that usually the UK would import seamlessly from the rest of the EU. And now, of course, it’s much more difficult. That creates scarcity which creates rising prices,” he explained.
4. Gas prices
Rising energy prices hit UK households and businesses hard – harder than in other European countries.
According to Reuters, Britain’s high rate of energy inflation shows it’s over-reliant on gas for heating homes. It also reflects the poor energy efficiency of its housing stock.
But Jacob Kirkegaard disagrees that energy prices are the main driver behind the UK’s inflation rate.
“Natural gas prices in Europe today are not as high anymore. It is true that UK gas prices rose more than in many other European countries, but frankly, they should also have come down more in recent months,” he said.
“The fact that this decline in energy prices has not caused the overall level of inflation to decline nearly as much as in the rest of the EU indicates that, in my opinion, the bigger issues today are not on gas, but in other parts of the UK economy,” he added.
What’s the inflation rate in other European countries?
Luxembourg has the lowest rate at just 2.7 per cent, followed by Belgium at 3.3 per cent, then Cyprus and Spain both which have a rate of 3.8 per cent, according to Eurostat.
But there are EU countries performing worse than the UK. Hungary has an inflation rate of 25.6 per cent, the Czech Republic 16.5 per cent, followed by Poland at 15.2 per cent.
How did countries like Luxembourg, Belgium and Spain manage to keep their inflation rates lower than the UK?
“In the case of Spain, one of the main reasons for its lower level of inflation for a number of months is that they put a price cap on an important part of the energy sector. That was very effective in keeping the inflation level down,” said Kirkegaard.
“The big reason why in the last six to nine months you’ve had such big differences in the level of inflation across particularly the euro area countries is that governments have implemented different variations of price controls on gas or electricity, and other countries haven’t done that at all”.
The Bank of England now expects inflation to fall to 5.1 per cent by the end of the year, which is less of a drop than the 3.9 per cent that was forecast back in February.
