When we last spoke in early 2020, Brexit seemed to be the biggest concern for the European economy. Then covid appeared, and Brexit seems to have been somewhat put aside. We have spoken to James Smith after nearly four years to discuss the outlook for the UK economy and what it all means for Czech businesses.
Can you first briefly summarise the main milestones in UK-EU relations from 2020 to the present?
Although the UK did leave the EU at the beginning of 2020, the biggest change to UK-EU relations only came a year later, when the EU-UK Trade and Cooperation Agreement (TCA) was reached. It was essentially a free trade agreement, although the UK decided it didn’t want to be part of the EU single market and customs union. That was definitely the main milestone where the new rules of play were set.
In 2021, the UK-EU relations were pretty restrained, mainly due to the issues in Northern Ireland. The then UK government wanted to make unilateral changes to the rules governing trade between Northern Ireland and the rest of the country. In the extreme-case scenario, the EU could have terminated some parts of the trade deal in return. These risks were obviously a big concern for businesses. And then we had a lot of political turmoil in 2022. Now Rishi Sunak has been Prime Minister for over a year, and the relations have improved over that time. The UK has recently re-joined the Horizon research programme for instance, and earlier in 2023 the so-called Windsor Framework was signed, which is a legal agreement clearing up a lot of small issues which were affecting trade particularly between Great Britain and Northern Ireland.
Does it mean that our relations are getting better again?
In my view, it’s all an important symbolic improvement in our relations. All in all, the UK is obviously outside of the single market and customs union, and there are a lot of new frictions and paperwork for businesses, but the very fact that the UK and EU aren’t always at loggerheads anymore is surely better for businesses, as it gives all of us more stability.
Inflation is the biggest concern
Now the biggest economic concern is inflation, and the UK is no exception. The country has struggled with high inflation, same as many EU countries. Is there a light at the end of the tunnel, any turning point on the horizon for Britain?
Yes, the inflation is coming down and the overall situation is improving. Interestingly, some four months ago, the prevalent view was that the EU had a much worse inflation problem than the rest of Europe, and that view had really gained traction in financial markets. But over the summer, it has become clearer that the UK inflation is much more similar to what’s going on in Europe. We saw a double-digit inflation towards the end of 2022, now the inflation is at 6.7% and will be probably around 5% at the end of this year.
The good news for the UK is that gas prices are now much lower, and supermarkets for instance are now also paying less for the food they purchase then they did a few months ago. Consumers should therefore see lower prices again soon. Higher supply and lower demand – completely reversed from the pandemic years – are also good for lower inflation. On the other hand, inflation is still going up in services, particularly travel and hospitality, but even there it might be starting to turn the corner with the energy prices now coming down.
New trade frictions
How much have these factors - Brexit, covid and inflation - negatively affected mutual trade between Britain and the EU? Or, specifically, with the Czech Republic?
Since these three big shocks came in quick succession, it’s very hard to disentangle the impacts of one from another. But if you look at what happened to the UK-EU trade since the TCA came into place in January 2021, you see an immediate impact as there was a lot of disruption at the border and goods exports from the UK fell very sharply.
UK exports to EU are still down by 8-10% compared to the pre-TCA period, while UK exports to non-EU countries are more or less on the same level as in January 2021. That gives us a bit of idea on how big the impact of Brexit alone has been on our mutual trade.
I see a lot of business opportunities within green transition for the UK
Studies show that there have been fewer individual trading relationships between the UK and EU. That is, the number of companies trading with one another has gone down, which means there are a lot of businesses on both sides of the Channel who have seen a lot of new frictions and costs, so it's simply no longer economical for them to trade with their UK or EU counterparts. That’s always more true of SMEs, because unlike large companies, they may not have the legal and the resources to help them deal with these changes.
What is Bank of England’s current policy for taming inflation?
The Bank of England was one of the first to start raising rates, back at the end of 2021. Since then, it has raised rates by five percentage points, so it’s certainly been very aggressive in trying to tame inflation. Now it looks like the rate hike cycle has finished – the BoE has kept rates on hold in September and we don’t expect them to change that. At the same time, they have been very clear that they want to keep rates high for a long time. The UK mortgage market also plays a role – the vast majority of UK mortgages are fixed, but not for too long. As a result, the impact of higher rates on consumer market has not quite come through yet. By contrast, businesses are inflating rates more commonly, so they have seen the impact already.
Labour shortages and rising costs
How have UK businesses been impacted by labour shortages in the UK market?
A lot of people have left the labour market for various reasons, and they have not returned – unlike the EU or even the US. As a result, there are a few hundred thousand people in the UK who are not employed or looking for a job. Partly it’s down to long-term sickness, partly early retirement, plus a lot of EU nationals went back home during covid. All these factors have contributed to worker shortages, and the result is that wage growth in the UK is generally higher at around 8% than in West Europe, where it’s around 4.5%. For businesses, that’s obviously a much bigger cost pressure, particularly in the services sector.
More optimism thanks to growing business investment
What implications do these factors have for European companies doing business in the UK? What should they keep in mind?
So far we’ve mostly spoken about the challenges, but I’d like to point out that business investment for example has actually gone up over the last year. That’s an important turnaround because business investment was consistently flat during the whole Brexit uncertainty, and the lowest in the G7. All in all, despite the bigger trading frictions, businesses now at least know what to expect. There is also more optimism after covid at least in the services sector, which has helped the investment growth as well.
But of course it’s still a challenging environment for businesses – the high interest rates will be an issue over the next few years, but that will be the same everywhere. Staff shortages certainly won’t help either, plus consumer demand is still relatively weak.
Do you see any more good prospects for the UK economy in the near future?
I see a lot of opportunities within green transition for the UK. It has been a big success so far, and there’s a lot of public investment required in the coming years, which is a big opportunity for businesses. As in most countries, a lot of things also depend on politics. We have an election coming up about this time next year, and polls suggest there will be a change of government – that will also set the tone for businesses.
James Smith was interviewed by Daniel Libertin
Photo credits: James Smith
