U.K. economy grapples with inflation

A series of shocks have combined to send prices spiraling in the U.K. The economy is struggling.

The war in Ukraine has further pushed up energy prices in the U.K.

The U.K. is entering a summer of discontent. It remains the world's fifth-largest economy in terms of GDP. However, its vital signs are causing increasing concern as an escalating cost-of-living crisis takes its toll on consumers. Last week, the Bank of England warned that the U.K. economy would fall into recession this year. Despite predicting a sharp fall in household incomes, it raised its main interest rate to one per cent, the highest level in 13 years. That saw the U.K. currency, the pound, fall by more than two per cent, hitting a two-year low. When announcing the news, the central bank's governor, Andrew Bailey, said he expected a "very sharp slowdown."

The public is increasingly pessimistic. Recent consumer sentiment surveys from research groups GfK and Refinitiv/IPSOS found that British households were more downbeat about their personal finances than in any other major economy in Europe. The GfK survey found that the British public's confidence in their personal finances was now at its lowest level since 1985.

Dizzying inflation

At the core of the problem is soaring inflation. The Bank of England expects it to hit 10 per cent by the end of 2022, driven by a combination of factors, including soaring energy prices and post-pandemic supply chain disruptions. Inflation is now a major problem across Europe and much of the world, but some experts have said that the energy price cap in the U.K. — a regulation that sets the maximum amount energy suppliers can charge over certain periods — means some cost increases are still to come for consumers.

"The U.K. probably has more inflationary pain to come than most other countries because the impact of the post-Russian invasion is yet to filter through to consumer prices," Andrew Goodwin, chief U.K. economist with Oxford Economics, told DW . "As the cost-of-living squeeze continues to intensify, we expect to see the consumer sector fall into recession."

The energy price cap was introduced by the U.K.'s market regulator in 2019 to prevent energy suppliers from immediately passing on higher wholesale costs to consumers. However, the rapid surge in energy prices over the past year, exacerbated by the war in Ukraine, meant a new energy price cap level was introduced from April 1. Another price cap increase is expected in October and several analysts predict that that increase will result in energy prices doubling in the space of a year for millions of households.

"We would see consumers and households paying even more, and especially for more vulnerable households, it is already having quite a drastic impact," Kay Neufeld from the economic forecaster Cebr told DW . A survey by the U.K.'s Office for National Statistics for March found that around a third of the people said the cost-of-living crisis had prompted them to cut back on essentials such as food and heating.

Dreaded stagflation

Michael Saunders, a member of the Bank of England's rate-setting committee, warned this week that inflation was now "uncomfortably high" and that those on the lowest incomes would be worst hit by the energy price increases. The bank's deputy governor Ben Broadbent underlined the scale of the problem facing the U.K. earlier this year when he said it was "doubtful that the U.K. has ever experienced an external hit to real national income on this scale." It has all put a lot of pressure on the U.K. government to act.

On May 10, Prime Minister Boris Johnson introduced the government's legislative agenda for the 2022-23 parliamentary session. Johnson highlighted a £22 billion (€25.8 billion, $26.9 billion) support package aimed at dealing with the cost-of-living crisis. But he admitted that the severity of the problem was such that the government could only attempt to mitigate the damage. Keir Starmer, leader of the opposition Labour party, said the country was facing a "stagflationcrisis," meaning a combination of high inflation and lackluster growth.

Neufeld from Cebr said the government has been slow to come to the rescue of the poorest households and much of the criticism it has received has stemmed from that. "It was quite clear that any support that you would give to the lower-income households would probably help them a lot," he said. "It also would help the economy a lot because this group has a very high propensity to spend every different income that they get." James Smith, developed markets economist at ING bank, told Reuters recently that the U.K. had done far less than other major European economies to try and help consumers deal with surging prices.

Trade war still on the horizon

Although the major global shocks of the pandemic and the war have distracted from it somewhat, Brexit also continues to cause problems for the U.K. The E.U. and U.K. are still at loggerheads over the Northern Ireland Protocol, despite the E.U. having made significant concessions in negotiations over the past year.

The U.K. has repeatedly threatened to introduce domestic laws which would overrule the Protocol, something which would be a breach of international law. This week, U.K. Foreign Secretary Liz Truss said she would "not shy away" from acting unilaterally. Such action could lead to the E.U. suspending its trade agreement with the U.K., which could lead to a trade war — a far from optimal addition to the list of problems facing the government.