Economists put reason for divergence down to Brexit and Britain’s energy price guarantee

The eurozone’s annual inflation rate fell by more than expected in June to 5.5% amid sharp falls in the cost of energy, highlighting an increasingly stark divide with stubbornly high price growth in the UK.

Consumer prices across the eurozone rose by 5.5% in the year to June, down from an annual rate of 6.1% in May and below forecasts for a reading of 5.6%, according to Eurostat.

The EU’s statistical agency said energy contributed the most to the falling headline rate, after a 5.6% fall in the average price in the year to June, compared with an annual decline of 1.8% in May.

Food, alcohol and tobacco inflation slowed from 12.5% in May but remained in double digits at 11.7% as households continued to come under pressure from the rising cost of the weekly shop.

The Eurostat figures contrast with the UK’s annual inflation rate, which remained elevated in May at 8.7% – the highest level in the G7 – amid growing fears the Bank of England will be forced to drive interest rates above 6% to try to bring inflation back down to its 2% target.

Separate figures published on Friday showed the UK economy grew at the slowest rate in the G7 in the first quarter of the year, apart from Germany, which is in recession.

Neil Shah, the director of research at the investment research firm Edison Group, said “Brexit was partly to blame” as increasingly “stark” differences begin to emerge between the UK and the eurozone.

“Britain’s toxic combination of the energy price crisis and deeply embedded labour shortages have resulted in UK inflation being far more stubborn than its fellow G7 economies. Brexit is partly to blame here, reshaping the labour market and putting pressure on employers to raise wages to attract talent.

“Britain’s economy, which is heavily reliant on services rather than manufacturing, is another point of difference to the slightly more balanced economies of European countries like Germany. Progress remains slow, yet the EU’s headline inflation figures are going in the right direction. Will we be able to say the same of UK inflation in July?”

Economists said most of the reason for the divergence between the UK and the EU was down to the UK government’s energy price guarantee (EPG), which has capped the cost of gas and electricity bills to the equivalent of £2,500 a year for a typical household until July. In the eurozone there have not been similar caps fixing the price over a lengthy time period, meaning their inflation rates better reflect the recent global decline in wholesale gas and electricity prices.

After the EPG expires this Saturday, energy prices will be dictated by the newly lowered price cap set by the regulator for Great Britain, Ofgem, equivalent to a typical annual bill of £2,074. However, forecasters have said the cost of gas and electricity is likely to only fall slightly by the end of the winter and remain at historically high levels.

James Smith, an economist at the Dutch bank ING, said energy prices as measured for the UK’s inflation rate were expected to fall by almost 20% in July. “We have the cliff edge; some countries are doing different things,” he said.

“In general, there was a much more rapid feed through on the way up from higher gas and electricity prices, they saw that earlier for consumers, but are subsequently seeing the falls as well. By the end of the summer the differential [with the eurozone] will be a bit less.”

Analysts said the UK was facing larger inflationary pressures owing to labour shortages, as companies across the country push up wages in an attempt to fill near record numbers of job vacancies.

The UK remains an outlier for increasing employment levels since the Covid pandemic, amid record levels of long-term sickness among working-age adults. Post-Brexit migration rules have also been highlighted by employers as one of the reasons behind difficulties in recruiting staff.

“That’s the main difference,” Smith said. “There you would see the UK’s specific longer-lasting increase in inactivity, and more acute worker shortages as part of the story.”