Is the UK economy heading for stagflation?

  • Describe the economic conditions in which stagflation happens
  • Learn about the consequences for investors of stagflation
  • Explain the different types of inflation

Prices rising at a faster pace than demand might then be expected to lead to demand falling, and economic growth slowing, as consumers and businesses are unable to afford the higher prices and so cut back.

Such a phenomenon is usually temporary, as companies adjust the amount they supply to win more business, and prices fall in response to the extra supply. This helps to boost demand, and the cost-push inflation turns to the more benign demand-pull inflation. 

For stagflation to take hold, the relative lack of supply in relation to demand must become entrenched in the economy, a scenario known as a “supply shock.”

The stagflation of the 1970s was sparked by a sharp increase in the oil price, which pushed up the cost of almost everything in the UK, and subsequently reduced demand.

George Lagarias, chief economist at Mazars, says the UK and much of the rest of the world is presently experiencing a series of pandemic-related supply shocks.

Supply shock

The first is the disruption to supply chains, creating a shortage of many goods in the UK, pushing up prices for goods such as those used in home renovations. 

The second supply shock comes from the requirement for people to self-isolate if they have been close to someone who has tested positive for Covid. This is creating labour shortages, and pushing up wages.

Lagarias says the market's general view has been that such supply issues are “bottlenecks” caused by the pandemic, and so would be temporary in nature. But he says, the low vaccination rates in many Asian and African countries, whose economies are a crucial part of the global supply chain, are likely to be disrupted by the pandemic for an extended period, impacting supply across the world.

For this reason, he think it is “increasingly probable” that inflation could rise materially next year and growth fall, giving rise to a period of stagflation that he believes would last “for a few months”. But he says that if conditions worsened from here, then such a period could last for many years.

He does not believe that inflation will rise to the levels seen in the 1970s, but argues it will be much higher than has been the case for the past decade, and with very little growth.

Paul O’Connor, head of multi-asset at Janus Henderson, says: “The economy and the market in the second quarter of this year have certainly had the whiff of stagflation about them. Central banks are becoming less comfortable with the inflation we have. The price pressures in the economy are most acute on the supply side, which is not a good mix. “