Is Britain heading for stagflation?

"Darling's desperate," said the FT. Alistair Darling has announced a rise of £600 in the personal tax allowance, amounting to a handout of £120 to those on low and middle incomes. This compensates most of the losers from the decision to abolish the 10p starting rate and has quelled a backbench rebellion over the issue just ahead of a by-election.

This latest retreat by the Treasury "has shattered any residual idea" that this Government can run "an orderly fiscal policy". What's more, the public finances can't afford the £2.7bn the concession will cost. Unless taxes rise, the Government will miss its repeatedly trumpeted self-imposed rule of keeping net public debt below 40% of GDP.

The slowdown is gathering pace...

Still, Britain's biggest worry isn't the Government's "unprecedented fiscal incompetence", as Damian Reece put it in The Daily Telegraph, but the spectre of stagflation as the economy tanks, yet inflation remains high. The RICS housing market survey for April showed that the balance of surveyors reporting falling prices fell to -95%, the lowest reading since its inception 30 years ago.

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The deepening housing slump amid tightening lending criteria is denting confidence and now it seems consumption is "starting to give way", said Michael Saunders of Citigroup. Annual growth in retail sales has hit a three-year low. Unemployment has begun to rise and is set to "keep climbing as the downturn deepens", said Capital Economics. "The risk of a vicious circle of falling house prices and rising unemployment is growing by the day."

but inflation is rising

Meanwhile, however, inflation is rocketing. Producer prices jumped by an annual rate of 7.5%, a 21-year high, in response to a raw material costs rising by a whopping 23% over the past year. The annual rate of consumer price inflation jumped from 2.5% to 3% in April, with food and energy the main culprits, but "there are also worrying signs of core domestic inflation", noted the FT. Core inflation jumped to 1.4% from 1.2% and goods and services prices are now on the rise.

Throw in further likely gas and electricity price hikes, plus recent petrol price rises feeding through, and inflation looks unlikely to subside significantly soon. A hawkish May Inflation report from the Bank of England suggests inflation could remain above 3% until next year and makes it clear interest rates won't fall much any time soon; this raises the chance of a "deep and prolonged downturn", said Capital Economics. So, whether inflation ebbs away or stays elevated as the economy slides, we are in for a long hard slog.