Brexit left Britain more exposed to higher inflation, warns member of Bank’s MPC

Brexit has left the UK significantly more exposed to inflationary pressures requiring interest rates to be kept on hold for longer than markets expect, a member of the Monetary Policy Committee (MPC) argued today.

Megan Greene, one of the six members of the MPC to back a hold at the last meeting, noted that “inflation in the UK remains further above target than in the US and Euro Area”.

“My concern is this is because second-round effects are having a larger and more persistent impact in the UK,” she said.

Greene pointed to the negative impacts of Brexit in constraining growth on the supply side. The supply side determines how strong growth can be before its inflationary.

The Bank of England’s most recent supply side stocktake forecast the UK’s potential growth rate would rise to around 1.3 per cent in 2026. The US, in contrast, has a potential supply growth of 2.2 per cent in the same period.

One of the key factors in determining potential supply is productivity, which in turn relies on investment. Greene noted that foreign direct investment has dropped from a peak of 9.6 per cent of GDP in 2016 to -2.3 per cent in 2021, although it has grown since the pandemic.

Source: Bank of England

This “strongly suggests” that Brexit is one factor behind the UK’s stagnant productivity, she argued.

Although Greene noted that the demand side was also much weaker than in the US, which would ease price pressures slightly, inflation still looked more persistent.

Services inflation is around two percentage points higher than in the US or eurozone, she noted, and the UK “stands out” when it comes to pay growth.

Greene warned that markets were not accurately pricing in the potential risk of persistence when considering rate cuts. “UK inflation is stickier than that in the US and this may not be reflected in the market pricing of rate paths,” she said.

“In light of the persistence of UK wage and services price pressures, which stand out in international comparisons, I think policy will need to remain restrictive for some time in order for inflation to sustainably return to target,” Greene concluded.

Greene’s comments come after a busy week of data for the UK economy. Data out this morning confirmed that the UK had slipped into a shallow recession in the second half of last year.

The figures will likely put pressure on the Bank of England to cut interest rates sooner rather than later to support the economy, although earlier this week Andrew Bailey said he would “not put too much weight” on the figures.

Inflation meanwhile undershot expectations, coming in at four per cent. Economists had expected it would pick up to 4.2 per cent in January. Lower-than-expected inflation eased concerns that wage growth had come in hotter than expected in the final quarter of last year.