Why Brexit is partly to blame for the inflation crisis

Eir Nolsoe
Wed, June 21, 2023 

Mark Carney says he has been vindicated after warning about the economic impact of leaving the EU - David Rose

When Mark Carney, the former governor of the Bank of England, who headed up Threadneedle Street during the Brexit vote, spoke to The Telegraph last week his message was: “We told you so”.

The Canadian said he had been vindicated after warning that the departure from the EU would push up prices, weaken the pound and hit growth.

On Wednesday, inflation data drove shock waves through the City after an anticipated drop failed to materialise and signs that price pressures are becoming embedded intensified.

The grim figures, which instantly fuelled a rise in the Government’s borrowing costs, are significantly worse than in comparable economies.

While Britain battled unchanged inflation of 8.7pc in May and the highest core inflation in 31 years at 7.1pc, the US and the eurozone are doing considerably better.

In the US, the Fed has paused raising interest rates after consumer price growth fell to 4pc in May.

Core inflation – which strips out volatile components like food and energy – eased somewhat by 0.2 percentage points to 5.3pc.

In the eurozone, the core measure fell by a near similar amount also to 5.3pc, while overall price growth slowed to 6.1pc in May, down from 7pc in April.

But this does not mean the UK’s rampant inflation can be solely blamed on Brexit – although most economists believe it has had some impact.

“A small part of the UK’s inflation problem is attributable to Brexit,” says Gregory Thwaites, a professor in economics at the University of Nottingham.

It is being felt in different ways, he says. Companies are being forced to pay higher costs to trade with the EU, which has a direct impact on imports.

The pound also remains lower than before the referendum in 2016, Thwaites says. But while there initially was a boost to inflation from the weaker sterling, he adds that has now been priced in.

“Then there’s probably a small effect also from the loss of migrants,” Thwaites says.

“So other things equal, if we were still in the EU, it’d be slightly easier to get workers from the EU and we would have slightly lower inflation because of that.”

The UK has suffered the same energy shock as the eurozone, while like the US it has also experienced a drop in labour market participation from Covid – meaning it is suffering the worst of both worlds.

Labour shortages – driven by a rise in long-term sickness and people choosing to retire early – have helped fuel record wage growth of 7.2pc in the three months to April.


This is higher than in both the eurozone and the US. Meanwhile, the absence of workers from the EU has added further constraints on labour supply.

The pressures have been most intense in industries that are typically less skilled and were until recently highly reliant on EU workers such as hospitality, retail and care work.

Ruth Gregory, of Capital Economics, says that the red-hot rise in pay is adding to pressure on core inflation.

“Some of that strength in the UK does stem from its bigger and more persistent shortfall in the supply of labour,” she says.

“I think part of that may be due to Brexit and part may be due to long NHS waiting lists which are contributing to labour market inactivity through long-term sickness,” she says.

This view is shared by James Smith at Dutch bank ING. He says that inflation in the cost of services has proved more stubborn “certainly compared to the eurozone”.

“Some of that will come back to the labour market inevitably,” he says.

“The extent to which that’s linked to Brexit, I think it is at least partly, but it is also born out of other trends. We seem to have this particular issue with worker illness, which other countries haven’t experienced.”

The UK has a whole host of problems, which means that separating the impacts of Brexit on inflation from shocks from the pandemic and the war in Ukraine is difficult.

One often overlooked aspect also comes back to productivity which has only just recovered to 2019 levels, says Thwaites.

This is where Brexit would have an impact by raising costs and “reducing the extent to which we can specialise in what we’re best at”, he adds.

Thwaites says the UK used to be able to have wage inflation of 4pc without consumer prices growing faster than 2pc, because companies were getting more productive every year. This meant they could pay higher wages with the extra productivity.

“Now we’ve got wage inflation of 7pc, we’ve actually got productivity falling by 1pc or something like that. So actually firms’ costs, rather than going up by 7pc, are going up by 8pc and that’s just their wage costs,” he says.

“The problem is we can’t handle any wage inflation at the moment because the productivity performance of the economy is so bad. That’s what we need to fix. That is partly to do with the way that we left the European Union but there are loads of other things as well.

“If you want high wages, you need to have high productivity, and if you want low inflation, you need to have high productivity growth.”

For now, Britain is stuck in a spiral of rapidly rising wages and even faster inflation.

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