Stagflation undermines UK economic growth

In March 2021, the UK’s annual inflation rate was just 0.7% on the Consumer Price Index (CPI) measure, Mehreen Khan says in The Times. A year later, it jumped to 7%, the highest value since 1992, and has yet to peak. The 54% rise in the energy price cap this month is expected to lift CPI inflation above 8% in April.

“Energy prices have reached another stratosphere,” says Deutsche Bank’s Sanjay Raja. Pump prices rose by 12.6 pence a liter between February and March, while fuel oil costs jumped 44%. While price increases are expected to ease a little over the summer, in October “we see headline CPI going over 9.5%” year-on-year.

There are already signs that “spiking prices for…everything from gas at the pump to food bills, rent and restaurant meals” are undermining economic growth, says Alex Brummer in the DailyMail. After rising 0.8% in January, GDP “barely increased in February”. For the first time in decades, the economy is facing stagflation (high inflation and slow growth). The “only silver lining” is that unemployment is now back to pre-pandemic levels and job vacancies are at an all-time high.

Inflation will take root

However, these staff shortages suggest that what started as a spike in energy and commodity prices could turn into broader, more embedded inflation, Jeremy Warner tells The Daily Telegraph. “We are already seeing some pretty successful pay deals…another period of union activism seems pretty much guaranteed.”

Central bankers in developed economies have been too slow to react to rising inflation, says Tim Wallace in the same article. The Bank of England only started raising interest rates in December, despite warning signs that had emerged months earlier that rising prices could spin out of control.

The Bank’s defenders argue that there is little interest rate hikes could have done to control soaring global energy prices. The problem is that when central banks fall behind the inflation curve, they have to raise rates more aggressively afterwards, which increases the risk of slowing economic growth.

The diet changes

It’s not just the UK. Inflation is 8.5% in the United States and 7.5% in the euro zone. Yet some investors still think the spike is temporary, says James Mackintosh in the Wall Street Journal. “Bond prices assume inflation will return to target without the Fed having to keep rates high.” The markets are implying an average US CPI of 2.4% for the five years after 2027. This is “probably a mistake”. From “retreating globalization,” to the costs of decarbonization and rising military spending, “a whole bunch of longer-term inflationary pressures are on the way.” With stocks and bonds both vulnerable to higher interest rates, investors are learning that “inflation hurts.”

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