United Kingdom

Since Brexit, the UK economy has been exposed to negative structural changes. First, labor shortages have reached record-high levels, notably in construction, food and accommodation and industry. Second, UK imports from China gained significant traction since the Brexit referendum, which the share doubling to more than 16%. At the same time, imports from the EU (notably Germany, the Netherlands, France and Belgium) have moderated. The higher dependency on Chinese imports, and more generally outside-EU inputs, is clearly a risk for future production in the UK, given the sensitivity to input shortages, which has clearly increased further in 2021.

Third, the economy has accumulated high twin deficits, above -6% of GDP, which coupled with fickle market confidence have pushed the UK government to switch to fiscal consolidation in the medium run. Despite being the first one to start, the Bank of England has been cautious in increasing interest rates too aggressively in 2022. However, given the high core inflation, we think they are likely to increase interest rates further into 2023 in order to avoid further strong depreciation of the currency, which is currently -15% undervalued. The pass-through to import prices is one of the highest in the advanced world as 55% of UK import prices are estimated to reflect changes in FX, compared to 10% in Germany or 5% in France. In addition, 30% of consumer expenditure is dependent on imports. Hence, looking at the historical pass-through, we see that a -10% depreciation would add a +3pp boost to inflation after one year. On the other hand, the growth boost is limited as the GBP depreciation is estimated to translate into a change in export prices equivalent to only 40% of the exchange-rate changes, and the pass-through can be even lower, given the weak global growth environment. Global trade is expected to grow at its slowest pace since 2019 (+1.2%).