- Low potential growth means economies more easily overheat
- But tackling the supply side is easier said than done
In May, Bank of America analysts warned that “the UK has one of the most severe persistent inflation problems among developed market economies”. Two disappointing inflation releases and one ‘double’ interest rate hike later, there is little doubt that they have a point – notwithstanding this week's better-than-expected price growth data.
The analysts say that “the UK economy has an entrenched inflation problem in our view because of weak potential supply growth and modestly de-anchored inflation expectations”. Estimates suggest that the UK’s ‘potential’ growth rate is just 1 per cent a year, which means that it takes only a very low level of ‘actual’ growth to hit full capacity, as the chart below shows. The economy is quick to overheat, and the consequences for inflation are grim.