Stagflation is sapping the UK's economic growth

In March 2021, the annual inflation rate for the UK stood at just 0.7% on the consumer price index (CPI) measure, says Mehreen Khan in The Times. A year later it has surged to 7%, the highest reading since 1992, and hasn’t peaked yet. This month’s 54% hike in the energy price cap should take CPI inflation above 8% for April.

“Energy prices have reached another stratosphere,” says Sanjay Raja of Deutsche Bank. Pump prices rose 12.6p per litre between February and March, while heating oil costs surged 44%. While price rises should moderate a little over the summer, come October “we see headline CPI pushing above 9.5%” year-on-year.

There are already signs that “rocketing prices for… everything from petrol at the pumps, to food bills, rent and eating out” are sapping economic growth, says Alex Brummer in the Daily Mail. After growing 0.8% in January, GDP “barely expanded at all in February”. For the first time in decades, the economy is staring at stagflation (high inflation and slow growth). The “one glimmer of hope” is that unemployment is now back to pre-pandemic levels and vacancies at a record high.  

Inflation will get entrenched

However, those staff shortages suggest that what started as an energy and commodity price spike could turn into wider and more embedded inflation, says Jeremy Warner in The Daily Telegraph. “We are already seeing some quite fruity wage settlements… another period of union militancy looks pretty much guaranteed.” 

Central bankers across developed economies were too slow to react to rising inflation, says Tim Wallace in the same paper. The Bank of England only started to raise interest rates in December, despite warning signs appearing months earlier that price rises could spiral out of control. 

The Bank’s defenders argue that there is little interest rate rises could have done to control soaring global energy prices. The trouble is that when central banks fall behind the curve on inflation they need to hike rates more aggressively later on, which brings greater risk of tanking economic growth.

The regime is changing

It’s not just the UK. Inflation is running at 8.5% in the US and 7.5% in the eurozone. Yet some investors still think this spike is temporary, says James Mackintosh in The Wall Street Journal. “Bond prices assume that inflation will come back to target without the Fed having to keep rates high.” Markets imply an average US CPI of 2.4% for the five years after 2027. That is “probably a mistake”. From the “retreat of globalisation”, to the costs of decarbonisation and more military spending, “a bunch of longer-term inflationary pressures are on the way”. With stocks and bonds both vulnerable to higher interest rates, investors are learning that “inflation hurts”.