Brexit has left Britain more vulnerable to inflation, the Bank of England’s chief economist has said

Brexit has made inflation harder to control in Britain and left the country facing “subsistence” price rises, according to the Bank of England’s chief economist, Huw Pill.

In remarks that will resonate with small and medium-sized firms still grappling with stubborn cost pressures, Pill said policymakers have found it difficult to rein in the pace of price increases since the 2016 vote to leave the European Union.

Speaking at a conference in Uzbekistan, Pill argued that the restructuring of Britain’s labor and goods markets brought about by Brexit has reshaped the economy in ways the Bank is “still learning” and “digesting”.

“My opinion is that those changes have led us to have a structure that is used to arbitrary prices, which can lead to the rate of inflation continuing,” he said.

The pill pointed to two forces in particular: new trade barriers thrown up between Britain and its largest trading partner, and the end of free movement of workers, which has eliminated many jobs in sectors that had long been dependent on European workers.

The numbers give weight to the argument. UK inflation has been around 3.6 per cent since the survey in June 2016, and has fallen below the Bank of England’s two per cent target for just one month in the past five years. At the same time, inflation in Germany has been 2.5 percent and inflation in France 1.9 percent, according to Bank of England analysis.

The picture is not entirely one-sided. Britain officially left the EU in 2020, just before the pandemic shut down much of the economy and triggered a wave of government support that fueled demand. Inflation then rose to a 41-year high of 11.1 percent in October 2022, as savings accumulated during the shutdown were released at the same time Russia’s invasion of Ukraine sent electricity prices soaring. However, that peak remained above the 8.8 percent achieved in Germany and the 6.3 percent seen in France.

Pill’s intervention comes just weeks after Andrew Bailey, the Bank’s governor, said the institution had been proven right in its earlier warnings that Brexit would damage the economy. Bailey called on the UK to rebuild its trading relationship with the EU, arguing that Britain’s shrinking markets are weighing on growth.

“I think the level of employment and economic growth has been low,” Bailey said. “If you reduce the size of our trading markets, and therefore reduce our export markets, that tends to have a negative impact on growth. It tends to have a negative impact on productivity and market size.”

Commentary builds on increasing evidence. The company-level data suggested that Brexit had reduced the UK economy by around 6 per cent, a figure in line with previous estimates that Brexit had a 5 per cent impact.

Labor pressure hits SMEs hard

Britain marked 10 years since the referendum last week, and the anniversary prompted a new round of stock-taking. In its assessment, Goldman Sachs concluded that businesses that rely heavily on EU workers “have experienced a significant increase in the number of vacancies since the Covid pandemic” as the new migration system affects existing workers.

For owner-managers, that’s more than an academic point. James Moberly, an economist at the bank, said the shortfall could feed directly into inflation as companies are forced to pay more to pass those costs on to customers at higher rates, a variable that falls flat on smaller firms with less capital.

“Going forward, a reduction in the cycle of migration flows compared to the pre-Brexit period could result in significant fluctuations in the strength of the labor market and domestic inflationary pressures,” Moberly said. He added that Brexit had “underestimated the performance of the British economy compared to other advanced economies”.

For Britain’s 5.5 million SMEs, the warning from Threadneedle Street carries a real sting. If inflation is now structurally difficult to change, interest rates could remain high for a long time, keeping the cost of borrowing, renting and day-to-day trading higher in the second half of the decade.