InvestmentsJul 26 2021

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
  • Describe the economic conditions in which stagflation happens
  • Learn about the consequences for investors of stagflation
  • Explain the different types of inflation
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Approx.30min
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Is the UK economy heading for stagflation?
Pexels/Anna Shvets

But the gains made by value equities have begun to fade, as investor sentiment switches from optimism to angst about the potential for economies to grow much more, and the extent to which the present spike in inflation is driven by supply-side factors, known as “cost push” inflation. 

This happens when the cost of bringing goods and services to market rises, forcing prices upwards, even if demand is not rising as swiftly. 

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.

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