Is the world heading for stagflation?

Inflation is on the rise again due to rising food and oil costs. But whilst inflationary pressures linger, the UK economy is set for a downturn as higher interest rates begin to bite.

Inflation is on the rise again. The annual rate of consumer price inflation jumped to 2.1% in October from the previous month's 1.8%, exceeding the Bank of England's 2% target for the first time since June.

High oil prices accounted for the lion's share of the increase, while dearer food up from 3.7% to 4.7% also offset falling gas bills.

Oil and food also accounted for half the jump in producer prices in October, with the price of food up 6%, the fastest annual rate of increase since 1993. Producers' selling prices are now climbing by 3.8%, a 12-year high.

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Inflationary pressure mounts...

"Food inflation is likely to stay high for years," as Tom Stevenson noted in The Daily Telegraph. Population growth, higher meat consumption in the developing world and the biofuels boom are boosting demand, while urbanisation and environmental degradation are squeezing the supply of land.

Developing Asia is also underpinning oil prices, while there's also the prospect of China beginning to export inflation rather than deflation. In October, Chinese inflation hit an 11-year high of 6.5%, with food-price inflation running at 15%; producer prices for manufactured goods are also creeping up. The surge in Chinese inflation over the past few months "has barely fed through into export prices yet but it will", said the FT.

...while growth falters

But while inflationary pressures linger, the economy is set for a downturn as five interest-rate hikes take their toll and credit tightens; house prices are off the boil and services growing at their slowest pace in five years.

The Bank of England expects growth to "slow sharply" next year and has signalled that rate cuts lie ahead, said Vicky Redwood of Capital Economics. But it is likely to wait until next year, given lingering concerns over upward pressure on inflation. In the eurozone, meanwhile, inflation is at a six-year high while economic headwinds are gathering strength. The impact of a strong euro, slowing global growth and tighter credit conditions has yet to be felt, says Martin van Vliet of ING.

But the contrast between sticky inflation and slowing growth looks most acute in the US, with Capital Economics pencilling in a jump in inflation to almost 5% by the end of the year, due to high oil prices and the likelihood of GDP shrinking in the fourth quarter. "This looks like stagflation." Throw in the plunging dollar, and the scope for rate cuts needed to shore up growth is limited, said Gary Duncan in The Times. "In turn, that points to a more painful outcome, not just for America, but for the rest of the world."