1. What makes the UK an outlier?
Inflation surged when economies emerged from the coronavirus pandemic as people spent money they’d saved during lockdowns, companies struggled to meet the resulting jump in demand and energy prices soared. In the UK, the Consumer Prices Index peaked at 11.1% in October and fell back to 8.7% in April — exceeding the expectations of economists and the Bank of England for a third consecutive month. The core rate of inflation, which excludes volatile energy and food prices, also accelerated unexpectedly and inflation expectations have been drifting well above the BOE’s 2% target. Inflation was running at 4.9% in the US and 7% in the euro zone in April.
2. What’s being blamed for the UK’s sticky inflation?
The UK is in a unique situation. It’s suffering from labor shortages like the US, while grappling with an energy crisis that’s afflicted all of Europe. The BOE’s task is made even harder by a surprisingly resilient economy, knock-on effects of Britain’s departure from the EU and a mechanism that shields consumers from high energy costs. BOE Governor Andrew Bailey said the price cap — which limits the cost of each kilowatt hour of energy — has slowed the pace at which a fall in energy prices feeds through into lower household bills. Some economists say this can explain almost all of the difference between the UK and other countries’ inflation rates and that the gap will begin to narrow from July. The second major factor is the tight jobs market. This tends to lead to higher wages, which in turn pushes companies to raise prices to offset their additional wage costs. At one point, there were more job vacancies than unemployed people in Britain, partly because more than 500,000 workers left the workforce in the pandemic.
3. Why does high inflation matter?
Britons tend to refinance their mortgages more frequently than their peers in the US and continental Europe, so lots of households are being exposed to the higher interest rates imposed by the BOE to get inflation back under control. About 1.3 million mortgage holders are set to refinance fixed-rate deals at a higher cost between May and the end of 2023. Borrowing is getting more expensive for businesses too. Wages are failing to keep pace with prices, exacerbating the worst cost-of-living crisis in living memory. Working-age people often face the biggest squeeze as older generations tend to own their house outright and receive pension payouts linked to inflation. The persistent inflation and prospect of more rate hikes is a headache for Prime Minister Rishi Sunak’s Conservative government, which is widely expected to fight another election in 2024.
Economists also believe Brexit has its fingerprints on the inflation troubles. Research by the London School of Economics suggested that a third of UK food price inflation from the end of 2019 to March 2023 was caused by Brexit because extra border costs added £7 billion ($8.8 billion) to grocery bills. BOE monetary policy committee member Catherine Mann warned the newly erected trade barriers made the UK “unique.” BOE Chief Economist Huw Pill said in February that the hit to supply and productivity from Brexit added to the risk of the UK economy overheating.
5. What’s productivity got to do with prices?
A workforce that’s less productive produces fewer goods and services, at a higher cost per unit, and this limits the economy’s ability to grow without stoking inflation. Britain’s productivity problems can’t be blamed entirely on Brexit, however. Growth in UK productivity was the second-lowest among the Group of Seven industrialized nations between 2009 and 2019. A long-running dearth of business and government investment has been blamed for the weak productivity growth since the 2008 financial crisis.
6. Will UK inflation cool off any time soon?
There are glimmers of hope for the BOE in recent economic data and on global commodity markets. The UK jobs market has shown clear signs of cooling, reducing upward pressure on wages. Experts say food inflation can only defy gravity for so long after sharp falls on global agricultural commodity markets. Some economists also believe that hot spots in April’s stronger-than-expected goods inflation will prove to be a blip.
7. When will the BOE cut interest rates?
It’s not clear. While the US Federal Reserve is shifting toward a pause in interest rate increases, the recent strong UK price data suggests the BOE may have to keep raising rates for now. Investors are betting on rate hikes throughout the summer and leaning toward a peak bank rate of 5.5% by the end of the year, a percentage point higher than the current level. One other factor making it hard to determine when the BOE should end its rate hikes is a longer lag in the impact of monetary policy — largely the result of shifts in the UK’s mortgage market in recent decades. The BOE estimates that only a third of the previous rate increases have fed through to the economy so far.
–With assistance from Andrew Atkinson.
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