The eurozone has proven surprisingly resilient over the last 18 months despite major headwinds, including an energy crisis caused by the war in Ukraine, a slump in the powerhouse German economy and high inflation. Yet economies like France and Italy are faring relatively well, in no small part because of government support and consumer spending. 

By contrast, Britain, once a major member of the European Union, has struggled. Outsize inflation has resisted containment, staying above 10% for the better part of the past year. It has lagged other major economies on several axes, particularly trade and investment.

What led to this? It’s a complicated question with no single answer. Despite inflation’s global nature, Britain’s tight labor markets and low economic efficiency make it especially prone to overheating from even modest increases in demand. That’s been compounded by the U.K.’s exit from the European Union — the so-called Brexit — which has further squeezed employers and added friction to important trade relationships.

This isn’t necessarily a permanent impairment, and Britain has several potential sources of strength. Its powerful financial center remains a source of economic might, and its education system is still highly regarded. But the sources of Britain’s high inflation are entrenched and could be difficult to resolve. It’s a multifaceted problem without easy solutions.

Britain’s high inflation reflects its unique set of challenges.

Even within the context of powerful global inflationary pressures, Britain has experienced particularly aggressive price growth. The inflation rate peaked at slightly more than 11% in October and exceeded 10% for eight of the past 12 months. Compare that with the eurozone, which peaked at 10.6% and only broke double digits twice. The U.S., despite its own travails with price growth, topped out at 9.1%. In May, Britain’s prices ballooned 8.7% over the last year, more than double the 4% U.S. rate. (The U.S. rate dropped to 3% in June.)

Worryingly, core inflation — a measure of generally more stable prices that strips out the volatile categories of food and energy — has risen in that period and now sits above 7%. With wage growth also running above 7%, I think underlying inflationary pressures are still building in the U.K. economy.

Some of the reasons for Britain’s higher inflation are easy to understand. The government provided less generous energy subsidies than in other countries, pushing inflation up higher for longer. Many goods and services, such as mobile phone costs and rail fares, are repriced annually according to the consumer price index, a practice that can slow the diffusion of rising prices to the broader economy but make elevated inflation persist. Some characteristics of the British economy also likely contributed — its consumers borrow more than their European counterparts, for example.

Additionally — and critically, in my view — the U.K. also has a long-standing issue with low productivity. In the economic sense, productivity is a measure of how much an entity produces with a given set of resources. Low productivity suggests inefficient and costly systems, and it can magnify other inflationary pressures.

Outside of what I consider an anomalous period in the late 1990s and early 2000s, U.K. productivity growth lagged most of its large European neighbors. That’s contributed to significant productivity gaps, with the U.K. now around 25% to 30% lower than Germany or France. Low productivity makes it harder to cultivate skilled workers and effectively build and reinvest in infrastructure — issues that can feed back into the system and further weigh on productivity gains.

Whatever its merits, Brexit exacerbated that issue. In a single action, Britain dramatically shrank its labor pool and increased the cost of doing business with its most important trade partners — outcomes that have weighed on its already anemic productivity.

Solutions have been hampered by on-the-ground realities and political sensitivities.

Britain’s central bank is aware of the challenges facing the economy given a deteriorating tradeoff between growth and inflation. Since December 2021, the Bank of England increased rates to 5% from near-zero. Further action seems likely — I expect it will raise rates at least another half a point, with an increasing likelihood that rates could rise close to 6%.

But the bank is conscious of the potential dangers of higher interest rates, particularly in the financial system. Last autumn, a jump in the yield on U.K. government bonds, called gilts, caused significant distress in parts of the financial system, forcing the bank to intervene to support the market. While this action was temporary, the bank is acutely aware of the potential for more financial distress, especially in the housing market.

Whatever their effect on inflation, interest rate increases have had a very tangible effect on one subset of consumers: Few British mortgages have long-term fixed rates; consequently, the average payment has grown by the largest amount in 30 years as a share of income. That very visible bite into personal finances has undercut the bank’s credibility with the broader public.

The issue of credibility is especially important, as this is the first test of the BOE’s ability to tame inflation since it became operationally independent. Some members of Parliament have offered their own solutions, including proposals such as homeowner aid that might exacerbate inflationary pressures. 

These difficulties aren’t insurmountable, but they are complex. Britain enjoys many advantages that could help it right its economy. Its financial industry is robust, and its educational system is among the world’s finest. My hope is that policymakers focus on long-term solutions to begin reversing some of these trends.