Brexit has made inflation harder to control in Britain and left the country exposed to “self-sustaining” price rises, according to the Bank of England’s chief economist, Huw Pill.
In remarks that will resonate with the small and medium-sized firms still wrestling with stubborn cost pressures, Pill said policymakers had found it tougher to rein in the pace of price rises since the 2016 vote to leave the European Union.
Speaking at a conference in Uzbekistan, Pill argued that the structural overhaul of Britain’s labour and goods markets brought about by Brexit had reshaped the economy in ways the Bank was “still learning about” and “still digesting”.
“My own view is that those changes have led us to a structure which is more prone to this sort of self-sustaining momentum in pricing, which can lead to greater inflation persistence,” he said.
Pill pointed to two forces in particular: the new trade barriers thrown up between Britain and its largest trading partner, and the end of the free movement of workers, which has drained the pool of available labour in sectors that long leaned on European staff.
The numbers lend weight to the argument. UK inflation has averaged roughly 3.6 per cent since the referendum in June 2016, and has dipped below the Bank’s 2 per cent target in only one month over the past five years. Over the same period, German inflation has averaged 2.5 per cent and French inflation 1.9 per cent, according to the Bank of England’s own analysis.
The picture is not entirely one-sided. Britain formally left the EU in 2020, just before the pandemic shut down much of the economy and triggered a wave of state support that fuelled demand. Inflation then surged to a 41-year high of 11.1 per cent in October 2022, as savings amassed during lockdown were unleashed at the very moment Russia’s invasion of Ukraine sent energy prices soaring. Even so, that peak sat above the 8.8 per cent reached in Germany and the 6.3 per cent seen in France.
Pill’s intervention lands only weeks after Andrew Bailey, the Bank’s governor, said the institution had been proved right in its long-standing warnings that Brexit would damage the economy. Bailey has urged the UK to rebuild its trade ties with the EU, arguing that shrinking the markets Britain trades with inevitably weighs on growth.
“I think the level of activity and growth in the economy has been lower,” Bailey said. “If you reduce the size of the markets that we trade with, so we reduce our export markets, then that does tend to have a negative impact on growth. It tends to have a negative impact on productivity and the size of the market.”
The comments build on a growing body of evidence. Company-level data has suggested that Brexit has knocked around 6 per cent off the UK economy, a figure that chimes with earlier estimates that Brexit dealt a 5 per cent blow to output.
The labour squeeze hits SMEs hardest
Britain marked 10 years since the referendum last week, and the anniversary has prompted a fresh round of stocktaking. In its own assessment, Goldman Sachs concluded that businesses most reliant on EU workers “have experienced the largest increases in vacancy rates since the Covid pandemic” as the new migration system bit into the available workforce.
For owner-managers, that is more than an academic point. James Moberly, an economist at the bank, said the shortages could feed directly into inflation as companies forced to pay more to recruit pass those costs on to customers through higher prices, a dynamic that lands squarely on the bottom line of smaller firms with thinner margins.
“Going forward, reduced cyclicality of migration flows compared with the pre-Brexit period could lead to greater volatility in labour market tightness and domestic inflationary pressures,” Moberly said. He added that Brexit had “materially weighed on Britain’s economic performance relative to other advanced economies”.
For Britain’s 5.5 million SMEs, the warning from Threadneedle Street carries a practical sting. If inflation is now structurally harder to shift, interest rates may stay higher for longer, keeping the cost of borrowing, recruitment and everyday trading elevated well into the second half of the decade.