Goldilocks flees as stagflation stages comeback

Former Federal Reserve chairman Alan Greenspan hardly has an unblemished forecasting record. Last year, for instance, he thought the US housing market was bottoming.

But it's hard to disagree with his statement last week that we are beginning to see "early symptoms" of stagflation, the combination of stagnant or lacklustre growth and high inflation that bedevilled the world economy in the 1970s and 1980s.

Inflationary pressure is mounting

Just as the US economy is heading south, the latest inflation data was "dreadful", as The Washington Times put it. Consumer prices jumped 4.3% year-on-year in November as food and energy prices rocketed; producer price inflation hit a 25-year high of 7.2%. And import prices, fuelled by the sliding dollar, rose by an annual 11.4%, the highest figure since records began in 1982.

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And there is "pressure in the pipeline", said John Mauldin on Investorsinsight.com. An index tracking the cost of materials for manufacturing spiked 8.7% in November alone. Moreover, a survey of the service sector shows that every industry polled reported higher prices, indicating that "inflation is starting to spread out".

The eurozone, too, has been reflecting "an unfavourable combination of rising price pressures and slowing activity", as Capital Economics noted. The latest harbinger of a slowdown is the EC economic sentiment indicator's slide to a 20-month low, while inflation hit a six-year high of 3%, above the European Central Bank's 2% target.

In Britain, where Dresdner Kleinwort now sees a 50% chance of recession, annual consumer price inflation remained at 2.1% in November, and sustained food-price rises and the prospect of higher utility bills could offset the effect of a consumer slowdown on retail prices, said Delphine Strauss in the FT.

According to Ian Castle of Lehman Brothers, if strong recent wholesale gas prices push utility bills up by 10%, "our CPI forecast could be close to 3%" by the middle of 2008.

What next?

The danger now is that higher commodity prices are passed on by businesses; the latest Bank of England survey shows manufacturers intend to raise prices over the next three months.

And consumers could demand higher wages to offset higher perceived inflation, triggering a spiral of higher salaries and prices: public expectations of inflation have reached the highest level on record, the Bank's figures reveal. EU Commissioner Joaquin Almunia has just warned member states to keep a lid on wages in the eurozone to prevent inflation being fuelled further.

And if inflationary pressures broaden, central banks will not be able to slash rates to stave off recession, warned the FT. Move over Goldilocks, said Larry Elliot in The Guardian. In 2008, we are likely to "hear a lot more" about her "spiteful twin sister", stagflation.