Peatland ecosystems contain one-third of the world’s soil carbon store and many have been exposed to drought leading to a loss of carbon. Understanding biogeochemical mechanisms affecting decomposition in peatlands is essential for improving resilience of ecosystem function to predicted climate change. We investigated biogeochemical changes along a chronosequence of hydrological restoration (dry eroded gully, drain-blocked <2 years, drain blocked <7 years and wet pristine site), and examined whether hydrological legacy alters the response of β-glucosidase kinetics (i.e. type of inhibition) to short-term drying and waterlogging. In the dry eroded gully at depth, low phenolic concentrations were associated with enhanced β-glucosidase enzyme activities (Vmax) but short-term drying and waterlogging caused a significant increase of dissolved organic carbon (DOC) and phenolics associated with increases in Vmax (enzyme production) and Km (indicative of competitive inhibition). Inhibition within the drain blocked and pristine sites at depth exhibited non-competitive inhibition (decreased Vmax), whilst uncompetitive inhibition (decreased Vmax and Km) occurred in surface peat explained by variation in humic substances and phenolics. These results suggest that loss of carbon by short-term drought or rewetting may occur from sites with a legacy of drought due to the release of non-inhibitory phenolics that permits enhanced enzyme activity.