Britain has a bigger inflation problem than either the US or the eurozone, according to .
The latest official UK inflation figures show UK price rises have slowed from double digits to for the 12 months to April 2023. But this is still above the .
The UK rate is also nearly double and significantly , which slowed .
All three regions experienced the economic shock of the COVID-19 pandemic. EU countries and the UK struggled with dramatically rising energy prices due to Russia鈥檚 war in Ukraine. But two UK-specific issues are exacerbating the country鈥檚 inflation woes: the adverse , and the UK鈥檚 reliance on its financial services sector.
As a result, interest rate rises by the Bank of England will not be enough to reduce inflation. The UK government should also play a role by away from financial services towards other traditional industries such as manufacturing.
Interest rates are a for fighting inflation, but they continue to be . They in several ways. The most obvious is in reducing demand for goods and services by increasing the cost of different forms of debt (such as mortgages).
But interest rates also affect whether businesses can meet their debt repayments and reduce the they provide to banks to secure their loans. This weighs on banks鈥 balance sheets and so interest rate increases adversely affect the financial sector because it there is a greater risk that these borrowers won鈥檛 be able to repay their loans. This is why an oversized financial sector creates headaches for the Bank of England when it tries to tackle inflation.
The UK鈥檚 industrial past
In the 1950s, the UK had a balanced economy . Manufacturing (including gas, electricity and water utilities) contributed over 40% of while the service sector accounted for 50%. The UK was responsible for a .
The government of the day , making the UK a , and a European hub for producing , , and to sell to other countries. Science-based industries, such as electronics, computers and engineering were also taking off in the UK, and the country benefited from this .
But advances in science-based industries did not happen soon enough to balance out a collapse in employment in manufacturing in the UK from the 1960s onwards. By 2011 around 80% of British workers were in service industries and . Various factors explain this decline in manufacturing jobs, including routine jobs being replaced by robots and computerised systems, rising imports from China and other emerging countries, and government policy.
In the 1970s, the government championed economic policies geared towards a housing boom and the financial hub of . The British public were told their future lay in working with their brains . De-industrialisation policies were instigated by UK prime minister .
These policies were presented as economic modernisation that would improve workers wages and society as a whole. Even the Labour government, , was convinced the future lay in the and embarked on making Britain a global service provider.
The rise of the , and the finance, insurance, and real estate industries, under both Conservative and Labour governments has . For example, the City has sucked the best-educated people out of other regions and careers and into high-salaried London-based jobs. People who might have become scientists or engineers became bankers or hedge fund managers instead.
So, even though the City , it is not a goose that lays Britain鈥檚 golden eggs but rather . It has crowded out other sectors that traditionally allowed the whole country to prosper.
And the UK financial sector is now causing another problem: its dominance has made it more difficult for the Bank of England to control inflation because of the concerns about how higher interest rates will weigh on bank balance sheets.
Tackling 鈥榮tubborn鈥 inflation
This is why alone will not be able to tame UK inflation. The bank has in anticipating the recent rise and persistence of inflation. But and have improved the ability to forecast inflation. On the other hand, unexpected government policies and the structure of the UK economy may have presented more of a challenge.
The bank鈥檚 models had little chance to account for the political turmoil and strategy changes resulting from Brexit. For example, between the UK and EU following Brexit, reducing supply and pushing up prices. There are also , putting pressure on wages in particular sectors and adding to the inflation problem.
Brexit, coupled with the oversized UK financial sector, makes the Bank of England鈥檚 job of controlling inflation so much harder. The government needs to rebalance the UK economy, with science-based industries playing an important role. This would ensure the Bank of England could adjust interest rates to tackle inflation, without having to worry about how it affects the over-sized financial services sector.
, Lecturer in Economics / Director of the Institute of European Finance, and , Professor of Banking,
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