Why is the UK economy doing worse than the rest of the G7?

The International Monetary Fund has warned that Britain is expected to be the only large industrialised country to face a shrinking economy this year.

The Washington-based fund upgraded its forecast for most leading economies but said it expected the UK economy to contract by 0.6% this year – a level 0.9 percentage points worse than that which it had pencilled in just three months ago, and slower even than that for sanctions-hit Russia.

Here are five reasons why the UK is suffering a worse performance.

Related: UK held back by staff shortages, Brexit and mortgage costs, says top economist

Cost of living

With inflation above 10%, household budgets can be stretched. While the annual growth in consumer prices is expected to slow this year – with Rishi Sunak setting a target to halve the inflation rate – the cost of living is still rising, though at a slightly slower rate than late in 2022.

The IMF said “still-high energy retail prices” would continue to weigh on households. The government has capped energy bills for typical usage at £2,500 annually on average, rising to £3,000 a year from April, and lasting until 31 March 2024.

After a fall in wholesale gas prices early this year some analysts expect bills could fall below the cap to about £2,200 from July. However, this figure is still about double the level late in 2021.

Tax increases

The IMF said “tighter fiscal and monetary policies” would also hit people this year – referring to tax and spending measures set by the Treasury and interest rates from the Bank of England.

After the financial meltdown triggered by Liz Truss’ “mini budget” Jeremy Hunt reversed the majority of those unfunded tax cuts. Higher taxes could dampen consumer spending power and weigh on business investment. By 2027-28 tax as a share of GDP is set to reach the highest level since the second world war.

Last September the IMF criticised the plans of the former prime minister Truss in a rare public rebuke, urging her to reconsider to prevent stoking inequality. Sunak is under pressure from the Conservative right for tax cuts. Others have suggested higher taxes on wealth could help balance the books.

Higher interest rates

The Bank of England is poised to raise interest rates on Thursday for the 10th time since late 2021, with an increase in the base rate to 4%. Economists expect this higher cost of borrowing to add to pressure on households and businesses.

As many as 2.7 million home owners with short-term, fixed-rate, mortgages are expected to pay at least £100 a month more to refinance their borrowing at the higher rates. With consumers and firms likely to rein in their spending to help meet higher borrowing costs, this could weigh on economic activity.

Labour shortages

Britain has suffered a decline in employment since the Covid-19 pandemic, fuelled by rapid growth in economic inactivity – a term used by statisticians to define when working-age adults are neither in a job nor looking for work. Older workers have retired early and there have been record levels of long-term sickness.

Unemployment in the UK could be three times higher than shown by official government figures, according to the Centre for Cities thinktank, which has said that more than three million working-age adults who report themselves as economically inactive could be added to official jobless figures.

Tougher post-Brexit migration rules are also adding to the shortages. The thinktanks UK in a Changing Europe, and the Centre for European Reform, estimate there that there is a shortfall of more than 300,000 workers due to the end to “free movement”.

Brexit

Business leaders warn that Brexit red tape and costs are harming UK trade. After an initial 40% drop in UK exports to the EU in the first month after the end of the Brexit transition period, overall trade volumes recovered. However, the UK has lagged behind the performance of other large economies.

According to figures from the Netherlands Bureau for Economic Policy Analysis – which tracks trends in global trade – UK goods export volumes remained 3.3% below their 2018 average in October, in contrast to an average 4.4% increase seen across all advanced economies.