While inflation rates are falling in the EU, the British are struggling with stubbornly high prices. This is also due to the high wages on the island – and Brexit.
Inflation is on the retreat across Europe. Whole europe? No, on an island in the Atlantic, inflation is resisting. In Great Britain, consumer prices rose by 8.7 percent in May – as in April. This development also came as a surprise to experts, as bank economists had previously expected the inflation rate to fall to 8.4 percent.
The development in the euro zone was completely different: consumer prices there rose by only 6.1 percent in May after 7.0 percent in April. Experts assume that inflation in the euro area has now peaked. However, economists are far less optimistic about the UK.
They are particularly concerned about core inflation, i.e. the development of consumer prices after factoring out volatile energy and food prices. UK core inflation rose in May from 6.8 to 7.1 percent – the strongest since March 1992.
These are the reasons for high British inflation
But why can’t the British get their inflation under control? What do they do differently than the Europeans on the mainland? The fact is: It can’t be due to the energy prices, they are falling – in Great Britain as well as in the countries of the European Union.
But there are far more inflationary factors than gas and oil prices. Experts therefore also refer to home-made problems. Politicians and central bankers have long underestimated the supply gap on the British labor market. Most recently, the number of vacancies remained high at more than one million. According to an analysis by the National Bureau of Statistics, around 300,000 people of working age left the labor market and have not returned to work during the pandemic.
labor shortage leads to higher wages
There are signs that labor shortages are more severe in the UK than in the eurozone. Whether harvest workers, construction workers, doctors or IT specialists: British companies are desperately looking for staff after Brexit, especially in the service sector. This has consequences – for British economic growth, which is severely slowed down – but also for wage developments. Because in a dry labor market, wages rise at an above-average rate, which in turn drives inflation.
As announced a week ago, wages in Great Britain rose by an impressive 7.6 percent on average in the first quarter of this year compared to the previous year – and thus significantly more than the Bank of England (BoE) had expected. For comparison: In Germany, the largest economy in the euro zone, nominal wages rose by 5.6 percent in the first quarter.
lower labor productivity since Brexit
“Although workers in the UK earn more per job than in neighboring eurozone countries, the average productivity of British workers is lower,” said Tomasz Wieladek, chief economist for Europe at T. Rowe Price. “In our estimation, this is probably a consequence of the significantly weaker investment growth in Great Britain since Brexit.”
Higher wages coupled with falling labor productivity – high inflation rates are inevitable. So it’s no wonder that the head of the Bank of England, Andrew Bailey, immediately predicted after the latest wage statistics that inflation would probably fall more slowly than expected. Ipek Ozkardeskaya, senior analyst at Swissquote Bank, said inflationary pressures are not under control in the UK, looking at the latest inflation data. There is therefore no way around further interest rate hikes.
A balancing act for the Bank of England
“While discussions are being held almost everywhere else about an imminent end to the cycle of interest rate hikes, that seems to be a long way off in Great Britain,” stresses You-Na Park-Heger. The currency analyst at Commerzbank speaks of a “special situation” for the Bank of England. At tomorrow’s meeting, the latter is likely to raise the key interest rate again – at least by 25 basis points; according to today’s inflation data on the markets, there is also speculation about a large interest rate hike of 50 basis points.
It’s a tightrope walk. With a monetary policy that is too strict, the British central bank risks completely stalling the already weakening economy on the island. But maybe that’s what it takes – a recession – to bring the UK’s stubborn inflation in check.