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BLOG: Are we in stagflation territory?

Paloma Kubiak
Written By:
Paloma Kubiak

Inflation has continued to rise, not just in the UK but globally. As supply pressures ease and commodity prices stabilise, we could be heading towards disinflation faster than many expect.

The Bank of England forecasted an increase to above 13% towards the end of the year, driven by surging gas prices.

But there are a couple of different dynamics at play.

Firstly, it’s important to remember that inflation is a global phenomenon, caused by various external economic factors. The world economies are still recovering from a two-year global pandemic that has massively disrupted supply chains. That has had an impact on pricing.

Meanwhile, there has been a “Covid euphoria” trade, particularly in the Northern hemisphere, where after being locked down for so long, people started spending a lot more on travelling and other activities. This excess demand, coupled with problems of supply, in any environment, would create short term inflation.

What’s exacerbated the issue this time around has been the war in Ukraine, affecting energy and food costs, both of which are an important proportion of mid-income and lower-income households’ expenditure.

Are we in stagflation territory?

Since the start of the year, there has been a lot of talk on stagflation. The definition of stagflation would be a combination of recession, high inflation, and rising unemployment. We’ve got the first two, but not really the third.

And so, while everyone is looking to draw parallels to the last time the UK has had stagflation, there are some key differences between now and the 1970s, including employment rates.

The last period of high inflation and interest rates in the UK started in the 1970s with the oil crisis, when the members of the Organization of Arab Petroleum Exporting Countries (OPEC) declared an oil embargo. Of course, Britain wasn’t the only country that was impacted that time around either. Any country that was reliant on OPEC oil supplies was affected.

But the UK had an unproductive economy where most manufacturing was owned by the state, and labour unions had significant power. There were widespread strikes, and the miners’ strike, in particular, impacted the only other source of energy that the UK could rely on amidst the crisis – coal.

It was also a period when there were major conflicts in the Middle East.

While that all sounds similar, this time around countries are much more energy self-sufficient, particularly the US and the UK.

The big difference is Covid. There wasn’t a global pandemic that shut down the world in the 1970s. There also wasn’t a war on mainland Europe although the ‘Cold War’ was still very much in evidence.

We are still a long way away from the days of the three-day working week, which was initiated in the 70s to ration energy consumption.

But as the pandemic comes to an end, we can be a little bit more optimistic on the outlook for inflation. Are we in stagflation now? With over five million people claiming sickness benefits you might argue yes. To be honest it doesn’t really matter as the remedies are the same as inflation.

‘Monetary policy cannot influence energy prices’

The reality is that whatever central banks do will have very little impact because monetary policy cannot influence energy prices. But higher energy bills will destroy consumer demand on discretionary spending.

We are already seeing the canaries in the coal mine with streaming services losing viewers, Cineworld considering bankruptcy and shops like Walmart struggling to sell discretionary items. As demand falls, so will the prices.

In June, the UK imported no oil and gas from Russia for the first time since records began in 1997. As oil and gas production ramps up and different sources are tapped for energy, the pressure on supplies should ease, although not soon enough for this winter unfortunately. Meanwhile, the price of other commodities such as industrial metals and agriculture has also started stabilising.

Therefore, as we approach Christmas, we could begin a period of quite significant disinflation. Moreover, if there is an end to the war in Ukraine, that will also be a big positive in both humanitarian and economic terms.

In this current environment, it’s important not to panic. It is true there remains a lack of visibility in the short-term, but there is the potential for positive surprises which could result in a swift rally in equity markets.

David Coombs is fund manager of the Rathbone Multi-Asset Portfolios