UK set for highest inflation among G7 until 2024, say economists

The UK is expected to have the highest inflation in the G7 not just this year but also in 2023 and 2024, according to economists, reflecting how Britain is struggling with a toxic combination of price rises recorded in Europe and North America.

A Financial Times analysis of the causes of price increases across the world’s leading economies shows that Britain — where the inflation rate hit a 40-year high of 9 per cent in April — combines the worst aspects of other G7 countries.

The UK is contending with a huge rise in the price of energy, like many countries in mainland Europe. But Britain is also grappling with a broad rise in the prices of other goods and services, like North America.

Energy prices, combining electricity, gas and road fuels, contributed 3.5 percentage points to the UK’s 9 per cent inflation rate in April, much the same as in Germany and Italy. It highlights how Europe has been badly exposed to rising energy prices as the global economy reopened following the Covid-19 pandemic, and Russia’s invasion of Ukraine has magnified the problem.

Meanwhile, other goods and services contributed 5.5 percentage points to UK inflation in April, similar to the US and Canada. As the pandemic has eased, goods and services have increased in price as consumer spending has outstripped companies’ ability to meet demand.

This combination of inflationary factors from Europe and North America puts the UK in the unenviable position of having the highest inflation across the G7 in April, and economists expect the situation to persist until 2024.

It highlights how Britain’s inflation rate risks being well above the Bank of England’s 2 per cent target for a protracted period.

Ben Nabarro, economist at Citigroup, said the government’s plan to compensate households for increases in the cost of living was “increasing the risk of more persistent [UK] inflation”, as well as intensifying the BoE’s dilemma in deciding how far to raise interest rates to curb price rises.

“This suggests the trade-off faced by monetary policy between [economic] growth and inflation is likely to become more challenging,” he added.

The UK shot to the top of the G7 inflation league table last month when the April figures included a 54 per cent rise in the regulated energy price cap that determines the level of most British households’ gas and electricity bills.

This pushed the annual rate of energy inflation including petrol to 52 per cent in the UK, higher than any other G7 country. It rose at an annual rate of 39 per cent in Italy in April.

France has placed strict limits on rises in household energy bills, while the US, Canada and Japan — by either being self-sufficient in gas or relying on it much less for electricity generation compared with many European countries — have not experienced soaring price increases.

Petrol has been the source of the largest price rises in the US, which were 44 per cent higher in April, compared with 31 per cent in the UK. Road fuels have increased more in the US because it has much lower taxes on petrol and diesel, so the cost fluctuates more with the global oil price than in most European countries.

Japan, which has contended with problematically low inflation since the early 1990s, had a rate of 2.5 per cent in April, of which 1.4 percentage points was because of energy price rises.

Andrew Bailey, BoE governor, last month suggested global forces such as Russia’s invasion of Ukraine and China’s zero Covid policy were behind the UK’s surging inflation — which the central bank expects to reach 10 per cent in the fourth quarter.

“To forecast 10 per cent inflation and then say . . . ‘There’s not a lot we can do about 80 per cent of it’ is, I can tell you, an extremely difficult place to be,” he told MPs last month, blaming the price rises on “energy and traded goods”.

The FT analysis of the drivers of inflation in G7 countries pinpoints how the UK combines the negative factors found in both mainland Europe and North America.

Energy price rises contributed only 38 per cent of UK inflation in April, compared with 50 per cent in France and Germany and almost 60 per cent in Italy and Japan.

It meant other goods and services provided 62 per cent of UK inflation, compared with 74 per cent in the US and 75 per cent in Canada.

High inflation is prevalent across a wide range of goods and services in Britain. More than 80 per cent of the UK’s goods and services that are included in the official inflation calculation have risen more than 3 per cent over the past year.

This suggests an imbalance between levels of UK consumer spending and the ability of companies to supply, partly as a result of additional trade barriers that accompanied Brexit.

Different spending habits by UK consumers compared with their counterparts elsewhere in the G7 are not obviously responsible for the higher level of inflation in Britain.

The FT recalculated G7 nations’ inflation figures using UK spending patterns, which are typically less focused on food and more on restaurants and leisure activities, but it made little difference to the overall comparisons between nations.

The broad nature of UK inflation raises the question of whether the BoE has the appetite to take sufficiently tough action to tame it.

While economists expect inflation to begin to fall later this year, there is increasing concern among business leaders that excessively high price rises will persist.

The Institute of Directors, a business lobby group, found in a survey that only 28 per cent of those questioned last month thought inflation would fall to the BoE’s 2 per cent target by the end of 2023, down from 33 per cent in April.

Kitty Ussher, IoD chief economist, said: “Disappointment in the performance of the UK macroeconomy, in particular around inflation but also in the everyday impact of Brexit, is affecting the very real investment decisions of business leaders.”

Source: Economy - ft.com