How Britain became the G7’s inflation outlier – in one chart | Inflation

The UK has a longstanding problem with inflation. Since the 2008 banking crash, bouts of inflation felt across the world have sent prices higher in the UK than its G7 rivals.

In July 2009, during the recession that followed the banking crisis, UK inflation was 3.1 points above the G7 average. Two years later, when recovery sent oil prices soaring, it stood about 2% above the G7 average. In March this year, however, it stood a full 3.5 points above the G7 level.

This week, the Office for National Statistics is expected to confirm an inflationary spiral that began in 2021 has again left prices higher in the UK than in most industrialised countries.

City economists polled by Reuters forecast that the consumer prices index (CPI) will in fact drop – from 8.7% in May to 8.2% in June. That compares, however, with the US inflation rate, which fell to 3% in June, and German and French inflation, which stood at 6.4% and 5.3% respectively.

The decline in the UK rate is modest, but the government believes it will mark the beginning of a dramatic slide below 5% between now and the end of the year; Jeremy Hunt, the chancellor, said last week on Twitter that the UK was on track to follow the US.

Hunt and Rishi Sunak have pledged to halve inflation by the end of 2023, which is widely interpreted as meaning a commitment to an inflation rate of 5% or lower.

Kay Daniel Neufeld, director of forecasting at the CEBR consultancy, says Hunt is likely to meet his goal, “though some might question his specific contributions to this feat”. Neufeld has forecast a fall to 4.5% by December – but mainly due to energy bills reversing sharply from last year’s highs. “We expect inflation in the ‘housing, water and fuels’ category to halve in July, falling to just under 6% before the rate turns negative in October, at around -3%,” he says.

There are several other factors that are acting to keep inflation high in the UK.

Britain has consistently registered the largest increases in food prices across western Europe, with inflation in this category peaking at more than 19% over the past year.

The average price of milk and eggs increased by more than a third during the year to April. Inflation for sugar and olive oil is running closer to 50%.

Freak spring weather across Europe must take some of the blame, but, more importantly, the UK is the world’s third largest net importer of food and drink, according to the UN Food and Agriculture Organization – behind only China and Japan – leaving it particularly exposed.

Ibrahim Quadri, an economist at Goldman Sachs, says he expects the ONS category of food, alcohol, and tobacco inflation to fall to 15.1% in June, from 15.6% in May.

Britain is also highly reliant on imported gas to generate electricity and heat, exposing it to the full impact of the surge in energy prices last year after Russia’s invasion of Ukraine.

The way Britain regulates energy prices – by announcing changes to maximum tariffs on a quarterly basis – means that international price rises are slower to push up inflation than in many other countries, but falls are also slower to feed through into bills.

France was able to avoid some of the price rises because it generates most of its electricity using nuclear power. German homeowners and industrial businesses cut consumption, but usage remained largely unchanged in the UK.

A more recent twist in the tale has been Brexit, which has created additional problems. Although London and the EU have an agreement allowing largely tariff-free trade in goods, there are barriers to exports and imports in the form of paperwork which causes delays and higher costs.

The end of free movement of workers from EU countries has contributed to a shortage of staff that is more acute in Britain than in many other economies, and which has pushed up wages – and ultimately prices – for consumers.

Additionally, the International Monetary Fund and the European Central Bank agree that analysis of corporate profits over the last two years shows that prices have risen in excess of the extra costs faced by firms. There is concern among some economists that the trend, which trade unions have called “greedflation”, is having a longer-lasting effect in the UK than elsewhere, and that supermarkets and other retailers are only now cutting prices in response to easing global supply chain pressures.

There are many theories about why the UK’s inflation rate has remained consistently higher than the G7’s, and why, in times of crisis, the gap widens.

Jagjit Chadha, the head of the National Institute of Economic and Social Research, said a major element hampering the UK could be found in the short-termism that governed investment decisions by businesses, the financial sector and government.

When there is an increase in consumer demand, “we hit our constraints very quickly, leading to a higher rate of inflation than in some other countries,” he said.

Chadha said another factor was the concentration of wealth, income and investment in London and the south-east. “This limits the capacity of the regions to react to events when they need to build up output to meet demand,” he added. “The money is not available for them to invest.”

A longstanding trend among UK businesses has been to exploit periods of rising demand after a recession, as in 2011, with higher prices rather than higher levels of production. This increases profits in the short term, but allows foreign competitors to enter markets with cheaper products, hitting the long-term viability of UK businesses that follow this path.

The UK’s low level of productivity gains since 2008 has also meant that any wage gains for workers cannot be absorbed by firms unless they take a cut in profits. Productivity, which measures a worker’s output per hour, has only inched higher across the developed world since 2008, but the UK ranks as one of the worst performers.

A higher-than-average exposure to the global trading system can also exaggerate the impact of inflationary pressures from other parts of the world. The UK has one of the world’s most traded economies, exposing it to almost any shocks in food prices or other commodities on which its industries depend.

The Office for National Statistics said in an analysis of inflation last year that the UK’s exposure to global markets is a factor in higher import costs across the board, also feeding into “core” goods prices, which exclude food and energy.

A country that imports a large proportion of the material that it makes into finished goods has a bigger problem than one that can source that material closer to home.

The ratio of trade – imports and exports – to GDP is about 25% in the US. In the UK the ratio is more than 50%. And the UK generally imports more than it exports, meaning that it runs a trade deficit. In 2022, a deficit of £231bn on trade in goods was offset by a surplus of £144bn on trade in services in 2022, leaving an overall trade deficit at £87bn.

The trade deficit worsened in May to £6.6bn, despite the lower price of gas on international energy markets, indicating that firms needed to import more goods to meet consumer demand, probably at inflated prices.