The British economy cannot tolerate further hesitation
The United Kingdom is facing an uncertain economic outlook — even more so than its neighbors — because the three elements affecting all developed economies are particularly relevant in the case of the British economy.
On the one hand, inflation has been much higher than average in recent years. This is similar to the case of much of Europe, and it is also attributable to external factors, such as energy or supply chain disruption. However, there is one fundamental difference: Brexit has magnified supply problems and monetary instability, in addition to increasing costs. Therefore, inflation in the UK could be permanently higher on account of these restrictions on supply.
These limitations are also affecting the job market. Some independent institutions calculate that one million active workers voluntarily left the job market during the pandemic, which would not have been the case under other circumstances. This is dragging production capacity down significantly; what's more, it may lead to a spiral of inflation in salaries if this remains the case over time. The circumstances are similar in other countries, but the British example is particularly intense. Firstly, because it is being compounded by Covid infection rates (around two and a half million workers are not available on health grounds). And secondly because, once again, Brexit-related policies have resulted in a sharp drop in the availability of foreign labor in certain key sectors.
The third factor is monetary policy. The Bank of England has gradually started to increase rates, taking the leap ahead of its European and US counterparts. This makes sense given that the risk of financial instability in the United Kingdom is greater. With real interest rates at historic lows, the incentive to invest in productive activities is practically zero; in turn, this is exacerbating the imbalance between supply and demand indicated above, thus threatening to perpetuate inflation. The circumstances are somewhat similar in Europe and the USA, however, in the United Kingdom, this impact magnifies the extraordinary restriction on supply caused by Covid and Brexit.
Although the BoE’s actions are justified, they are insufficient. In this case, little can be done to control inflation if it remains based on external shocks and restrictions on supply that are a result of economic or foreign policies, rather than monetary policies. Public action in this context is no mean feat; however, what is necessary is coordination between the Treasury, the monetary policy and the supply policy. The aim is to prevent the necessary actions by the central bank and the preservation of health causing more permanent damage to growth capacity. Therefore, all eyes are now on Parliament, rather than the BoE. And this represents a very tough task for an already battered executive. Unless strong proposals are made, the growth outlook will continue to contract.
Alberto Matellán, MAPFRE Inversión chief economicst.