By Vicky Pryce, Chief Economic Adviser at the Centre for Economics and Business Research and Chair of the BCC’s Economic Advisory Council (EAC)
The economic background can hardly be described as reassuring. Oil prices have been above $100 a barrel for too many days over the recent month, bringing rather closer the realisation of the IMF’s possible recession scenario which they had moved away from when prices fell back for a short period over the summer. Worries about an AI bubble and dire warnings about the end of the world if the technology continues with its uncontrollable pace of development all add to a feeling of malaise. Inflation is picking up again, interest rates look like they might be on the way up, and house prices are falling. Stock markets which have benefitted from strong energy companies’ and banking profits are now retreating from historic highs.
The apparent resilience of the UK economy should not obscure the fact that serious cost of living issues, what looks like a softening labour market, and an overall lack of investment except in AI and tech related areas are all issuing warning signs for growth ahead. Given that the UK’s debt to GDP ratio is in fact at the low end of most other G7 economies, one wonders why short-term interest rates and bond yields, though on the way up across the world, should be so much higher in the UK than those in most other G7 countries. And considerably higher than those in Europe.
A Widening Interest Rates gap
The difference in short term rates is also stark. The latest quarter of a percent rise by the ECB in September, still left their main deposit rate, at 2.50 %, a whole point and a quarter below that set by the Bank of England. And that gap is sure to widen as markets now anticipate a lift soon in the UK too as tensions in the Middle East and pressures on oil supply continue.
This is of course deeply concerning as it may be pointing to some structural failings. It is true that in its intention to improve public services, the new Labour government diverted revenues raised by higher business taxes to the NHS and other areas that needed extra support. In the process they arguably stifled hiring and spending intentions by firms and contributed to the prices charged to consumers being higher than they would otherwise have been. The extra borrowing of £ 30b a year through this parliament to achieve Labour’s public sector service improvement ambitions and its intended spending on needed infrastructure, has also contributed to the high yields. This has been made worse by the insistence of continuing with high levels of QT by the Bank of England.
But this does not explain all the difference in yields. Nor can it be attributed to the Bank of England being slow to respond to the increase in inflation post Covid as they were the first to raise rates in December 2021. While the US first raised rates in March 2022 and the ECB in July, where the main savings rate had stayed negative until then since 2014.
The ongoing trade barriers with the EU
In fact, the assessment of ex MPC member Professor Adam Posen, on the impact of Brexit was prescient. The Posen view was the obvious one, that erecting barriers to trade would inevitably lead to higher prices than would otherwise have been the case. Given also the significant presence of the EU in our overall import and export balance, Brexit could well, in his view, account for some 80% of the difference in inflation between the UK and the EU[1].
The truth is that the UK started the latest crisis from a position of weakness, with higher interest rates and inflation than would otherwise have been the case if still in the EU, limiting room for manoeuvre. And the economy, though obviously also hit by the tariff war and challenging geopolitics, has additionally, as many studies suggest, lost some 6-8% of GDP already compared to what would have been. With weaker trade so investment has also suffered, and productivity has also been affected by a sharp drop in European workers coming to the UK.
The labour and skills cost
Skills shortages are particularly high in construction. Research undertaken by ONS before the UK–EU Trade and Cooperation Agreement was signed suggested that EU nationals accounted for around 40% of London’s construction workforce[2]. Since the end of free movement, accessing workers from overseas to fill critical skills gaps has become considerably more complex and costly.
This reflects a wider challenge across the economy. The BCC’s research showed that more than half (58%) of businesses are facing skills shortages – around two thirds (67%) of firms said better access to skilled employees would support growth[3]. Impact assessments from the Home Office have also suggested that the new skilled visa regime with the higher salary requirements would add some £40bn to industry costs over 10 years[4].
EU workers had no such extra costs attached to their employment, had higher employability rates than local workers, had relatively few dependants arriving with them and on balance made fewer demands on social services than other categories of workers. In fact, in that ‘golden era’, they were the one section of the community which made a positive overall contribution to the Exchequer.
What SMEs have lost
The difficulty and costs in trading with the EU have been particularly onerous for SMEs. The BCC’s Quarterly Economic Survey has seen repeated declines in the proportion of SME exporters increasing their sales, and in 2025, 54% said the current Trade and Cooperation Agreement with the EU is not enabling them to grow, and only 16% said it was[5].
That affects long term productivity and competitiveness as well as limiting consumer choice. Trade is vitally important as an inducement to invest, innovate and compete. Any drop in trade intensity is known to be bad for longer term growth. If growth is indeed the aim, then the case is straightforward. Re-invigorating closer trading links with Europe comes at the top of what needs to be pursued. It is not just what economists pointing to the ‘gravity model’ of trade would tell you about the advantages, including on limiting environmental costs, that come from exchanging goods and services with your closest geographical neighbour. It is also what we have been witnessing displayed in practice over the last few years.
The case for a UK-EU Reset
Now that the tariffs charged by the US on UK goods no longer differ from those imposed on imports from the EU in any meaningful way, the advantages of going it alone disappear. And as the EU is pursuing, from a position of greater strength, deals with the same countries and regions the UK have reached out to on its own, including with India.
The issue of relations with Europe of course remains a vexing one and politics here must be considered. But more recently, particularly following the PM’s speech to the Labour Party Conference this week, the options of bringing part of the EU single market and/or a customs union are being flagged as real possibilities as concerns for sovereign security are intensifying worldwide, leading to many nationalistic and protectionist responses creating multiple obstacles to the UK’s open economy.
The PM even said “going all the way” with full EU membership for the UK was on the table too as part of a setting out of future EU relationship options for the UK around the time of the Leaders’ Summit, likely to be held in November this year. The EU itself is finalising its ‘buy European’ policy which could cause great harm to the UK unless it can be modified to include us too. Canada, ‘estranged’ for the moment from the US, seems to be trying to join European initiatives itself for greater protection.
It is becoming clear that remaining competitive as a middle power has become increasingly hazardous in this highly uncertain and dangerous geopolitical environment. Sensible policies would require avoiding going down routes which will be costly done alone, whether in AI, energy, defence or in finance and payments innovations. A fundamental reset in UK /EU relations is urgently needed. And it should be bold if it is to have a lasting positive effect on the UK economy.
[1] https://www.nber.org/papers/w34459
[2] https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/internationalmigration/articles/migrantlabourforcewithintheconstructionindustry/august2018
[3] https://www.britishchambers.org.uk/news/2026/09/lifelong-learning-crucial-to-tackling-youth-jobs-crisis/
[4] https://www.gov.uk/government/publications/changes-to-immigration-rules-impact-assessments/2024-spring-immigration-rules-impact-assessment-accessible
[5] https://www.britishchambers.org.uk/news/2025/12/eu-trade-getting-harder/