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There seem to be few things that the business press and economists like better than to be able to give a good label to some economic phenomenon.

For example, when economic growth slows, as it undoubtedly is now doing, the speculation about recession starts. The combination of slowing growth and rising inflation has led to a revival of the term stagflation in commentaries. Those with long memories will recall when the use of the term was in its heyday – economic growth was low and disappointing and inflation was roaring away.

The comments about stagflation at the present time, however, reflect a rather different experience, particularly with regard to inflation. Inflation has clearly picked up – consumer price inflation, at 3 per cent in April, is now at the extreme of its target range and has every prospect of heading higher in the coming months.

Indeed, some forecasters think that CPI inflation could rise above 4 per cent, particularly if oil prices keep to their upward march. Two things are of particular interest about the rise in inflation. The first is that even if CPI inflation hits 4 per cent, forecasters, such as the Bank of England, expect that such a high level will prove to be a relatively short-lived peak.

Pressures

The slowing of the pace of economic growth should reduce medium-term inflationary pressures, so that inflation in a year’s time would be lower than the high rates expected soon. Second, if inflation peaks at about

4 per cent, this will be much lower than the years that we generally remember as being those of stagflation.

Back in the 1970s and 1980s, retail price inflation was the key measure of inflation. In the 1970s, it never fell as low as 4 per cent, but reached a peak of 26.9 per cent in mid 1975. In the 1980s, there were several months when it fell below 4 per cent – and some when it was below 3 per cent – but this low inflation was not sustained.

As those in the housing market found to their cost, inflation rose again at the end of the decade, reaching 8.9 per cent in mid 1989 but then rose above 10 per cent in 1990. The difference between the experience with inflation in the 1970s and 1980s and now is really marked. If stagflation is to return as an economic feature for the UK, then the flation element is very unlikely to be at the same pace as it was in those decades. This is a key difference for those who use the term.

The Bank of England, of course, does little to control the price of globally-traded items such as oil. What it is therefore most concerned about is that as global factors raise inflation this should not result in expectations of inflation becoming too elevated.

The recent and current experience of higher inflation carries the risk of being transmitted through into higher inflation expectations and then into continued higher actual inflation. The Bank of England – and most particularly the Monetary Policy Committee – has stressed its commitment to the objective of attaining the 2 per cent inflation target, while it is recognised that some variability of experience around the target is inevitable in these difficult economic times.

As a result of the projections in the May Inflation Report, which showed a revised, higher inflation outlook, financial markets changed their expectations for further rate cuts in the coming months.

This change of view occurred despite increasing evidence of slowing economic growth. Survey readings on output have become less positive for manufacturing, services and, especially, the construction sector.

The indicator of activity in construction has dipped much more sharply than those for either manufacturing or services. The surveys of investment and employment intentions reported by the Bank of England’s agents have continued to become less positive and the Royal Institution of Chartered Surveyors surveys on new buyer enquiries and house price expectations have shown further reductions.

Expectation

All of these indicators support the expectation that overall output growth will slow further. This does not, however, mean a stagnation of output. It seems more likely that we are witnessing a cyclical change in which, after two years during which output growth has been above what is generally thought to be its trend rate of growth, output is set to grow below trend for a while before picking up again in a cyclical fashion.

The latest projections for gross domestic product growth from the Bank of England show this feature, with annual growth picking up in the second half of next year and reaching 2.5 per cent – a frequently used estimate of trend economic growth – in 2010.

For the MPC, the key issue is determining whether to change interest rates at a time when inflation is high and rising but growth is slowing. The former creates the risk that high inflation will continue, while the latter offers the prospect of lower inflation in the medium term but the risk of higher unemployment in the near future as a result of the economic slowdown. The dilemma now faced by the MPC looks at least as difficult as at any time since the committee was established just over a decade ago.

Barry Naisbitt is chief economist for Abbey