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Brexit’s Legacy Is Hotter UK Inflation Risk for Years Ahead

·3 min read

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The UK will be stuck with searing inflation for years because of Brexit, according to strategists at Wall Street’s top banks.

Citigroup Inc., Bank of America Corp. and Standard Bank all see the UK as a outlier in the developed world because of the economic damage wrought by the decision to cut ties with the European Union. Even as price pressures start to fade elsewhere, they say UK inflation will be higher-than-normal because of immigration controls and supply chain disruption. A report Wednesday showed price pressures hitting a fresh four-decade high.

Inflation is a big reason why investors are bearish on the pound, even with the currency trading near a two-year low to the dollar. The view among experts is that Brexit isn’t the cause of the cost-of-living crisis, but it will make solving the problem harder in the UK than anywhere else.

UK Inflation Rises to New 40-Year High With More Gains Expected

“Inflation in the UK will be stickier over the medium to long-term because of Brexit,” said Vasileios Gkionakis, head of European FX strategy at Citigroup. “The economy is extremely fragile and in desperate need of more fiscal support, which is unlikely.”

The Office for National Statistics reported on Wednesday that consumer prices rose accelerated to 9.1% in May, from 9% a month earlier. The pound weakened 0.3% to $1.2243.

Experts say it’s hard to know to what degree the UK’s economic woes are caused by the pandemic or the aftermath of Brexit. Some research suggests Brexit is already taking a toll. Trade barriers have driven a 6% increase in UK food prices, according to a report from the London School of Economics.

The links between Brexit, the economy and inflation aren’t always clear cut. Citigroup’s Gkionakis said it’s possible that slower growth in the UK could ease price pressures caused by Brexit in the near-term. Rate hikes by the Bank of England are another uncertainty for investors to reckon with.

“The market is currently telling us that the BOE will hike quite aggressively,” said Francesca Fornasari, head of currency solutions at Insight Investment. “If that turns out not to be the case, particularly when inflation is quite high, that’s one of the things that could knock sterling further down.”

To Bank of America’s Kamal Sharma, there’s a long list of reasons to still be negative on the pound. The economy is in poor shape and the BOE’s decisions are the subject of politicized attacks.

“As the pandemic headwind starts to fade, the UK will be left with this one big idiosyncratic shock,” he said. “For an economy that’s very reliant on domestic demand to drive the economy, that means you’re heading into a period of sub-trend growth, which is negative for the pound.”

Replacing access to the EU’s single market with labor and goods from elsewhere remains a challenge for the UK government, which has struggled to make headway on trade agreements. While the UK signed its first agreement with a US state last month, the piecemeal approach shows talks are failing to progress.

Among strategists, most expect the pound to keep weakening. Citigroup’s Gkionakis sees the euro gaining against sterling to around 90 pence by the end of the third quarter, from 86 pence currently.

To get inflation under control, the BOE may have to take a harder line on interest rates, according to Steven Barrow, head of currency strategy at Standard Bank in London.

“When we think about the next three to four years, not just the next 12 months, we believe there is every reason to expect that UK base rates will vault those in the US,” he said. “The market is not priced for this.”

(Updates market pricing in fifth paragraph.)

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