Stagflation is not a widely-used word in UK investment circles, because frankly, it’s a rather alien concept. Wealth managers are used to having conversations with investors about inflation and economic growth, but stagflation is a unique circumstance that hasn’t applied to the UK economy for many decades.
Stagflation describes the state of an economy with high inflation and low (or negative) economic growth. This condition is feared because when prices rise faster than wages and profits, society can afford to buy fewer goods and services than they could the year earlier.
It’s a usual affair because inflation is generally accelerated by strong economic growth. Therefore, high inflation usually accompanies good increases in workforce salaries. This is known as the ‘overheating’ of an economy. You’ll have seen this yourself – when everything is booming and money is easy to come by, prices head upwards as a glut of bidders competes to purchase supply-constrained goods like properties, holidays and vehicles.
Stagflation differs because its inflation is totally ‘decoupled’ from economic growth. This is a fair description of what is currently happening in the UK economy.
What is happening to inflation in the UK?
Inflation is caused by external factors, generally linked to the tight supply of core commodities, components or energy.
The war in Ukraine has created a fear of scarcity of natural gas because the trading relationship between Russian and European countries has deteriorated to the point where Russian spokespeople have openly threatened to cut off Europe from its plentiful energy supply.
The war has also disrupted the supply of wheat – a commodity that underpins the production of food staples such as bread and pasta. This is resulting in prices of basic foods increasing at the supermarket.
Finally, a semi-conductor shortage which began in 2020 with Covid-19 supply chain issues, and has continued through to 2022 following a strong rebound in demand, has led to the production lines for electronic items such as laptops and vehicles grinding to a halt.
Inflation is here to stay, at least for the medium term, says the Bank of England, as these supply constraints won’t be disappearing any time soon.
What’s happening to economic growth in the UK?
The UK registered growth in Gross Domestic Product (a measure of the value of goods and services produced by the economy) in 2021, although this was flattered by the terrible comparative year of 2020 which saw a chunk of the British workforce being furloughed at home and businesses temporarily shut due to the pandemic.
The British economy has now almost grown its way back out of the hole it fell into during the pandemic. At the worst point of the lockdown, the UK’s GDP fell by 21% in a single month. Recently, it increased by 24% during a quarter in 2021.
Now that the economy largely resembles its size prior to the virus crisis, we can expect that economic growth will return to the historical norm of 2%-3% per year, all things being equal.
But all things aren’t equal – the war in Ukraine and spiralling inflation have dented consumer confidence and there are even whispers of the possibility of the seemingly inoculated housing market also being the next victim.
Recent interest rate rises, coupled with a real possibility of a recession could finally give home buyers the dose of reality they’ve needed to prevent them from overpaying for properties in suburban UK.
Will stagflation persist?
With lower growth and disturbingly high projections of future inflation, it seems certain that 2022 will be a year of stagflation. The question investors are asking is: will it be with us for long?
The answer to that question lies within the answer to a question outside the economic realm: ‘when will Russia cease their war in Ukraine?’. This single conflict is the root cause for so much of the inflation we are seeing. And yet this author does not possess a crystal ball to predict its outcome. UK government sources in fact have warned the public that this war could drag on for years.
