WHAT IS STAGFLATION AND IS IT COMING OUR WAY?
What is stagflation?
Stagflation is a mixture of the words ‘stagnation’ and ‘inflation’. Stagnation describes when an economy stops growing, inflation is rising prices, and stagflation is when both of these things happen at once. Some experts also believe that unemployment also needs to be high for stagflation to exist.
Probably the most famous example of stagflation is from the 1970s, when the UK’s economy struggled greatly from an oil price shock. An oil ban against the UK, US, Japan and others led the oil price higher. Although this stoppage lasted only about six months, the price of other goods and services started to rise, many people lost their jobs and many UK businesses got weaker.
Unfortunately, stagflation has been getting a lot of attention recently because of concerns about prices going up and the potential for growth in the UK to stop.
Inflation has been closely watched in the UK over the past year. Prices started to rise as demand for goods and services improved once the pandemic lockdowns ended and because of problems with goods reaching customers. Russia’s invasion of Ukraine has since pushed prices of oil and other products even higher.
Annual inflation has now reached a 40-year high as prices increased 9% between April 2021 and April 2022, with energy price rises the main issue.
To try to reduce inflation, the Bank of England (which acts as a lender to the government and other banks) has increased its interest rate five times since December 2021.
Interest rates are charges to borrow money. These interest rate rises have led to rates on other loans for businesses and consumers becoming more expensive. The idea is that, if loans (like mortgages or car loans) become less affordable, people and businesses will cut back on spending on other goods and services, which will reduce demand – and prices. Of course, if people cut back too much, it could also damage the UK economy and growth.
The UK economy bounced back in 2021 after falling in 2020 when the pandemic and lockdowns hit hard. Now many economic experts are worried about whether that growth will continue. Although the UK grew over the first three months of 2022 (compared with the final three months of 2021), the economy shrank in both March and April.
Meanwhile, price rises are meaning people have less money in their pockets, which may have an impact on growth. The Bank of England has a tricky job to balance growth and inflation – if inflation can’t be controlled and growth struggles, then two of the three conditions for stagflation will have been met. Indeed, by some definitions of the term, as we saw earlier, rising inflation and no growth would already mean stagflation.
At the moment, the third condition – high unemployment – has not been met. Indeed, in the three months to March, the unemployment rate fell to 3.7% – a level not seen since 1974.
However, while wages have risen they’ve not matched the pace of inflation. This could affect how much consumers spend in the months ahead. If demand for goods and services falls back and the economy slows, businesses may reduce the number of people they employ and the unemployment figure could start to rise.
There are several issues that could cause problems ahead. There’s been financial markets uncertainty and concerns about the Russia-Ukraine situation, which has caused difficulties in the delivery of some goods and added to concerns over prices and growth.
Given this backdrop, it is understandable that investors are concerned about the potential for stagflation. However, the Bank of England is aware of the current problems and will probably look to tread carefully as it considers its next policy moves.
Economies can see ups and downs. Periods of difficulty can be unsettling, but for longer-term investors we believe it is important to avoid hasty reactions. Instead, it can be helpful to focus on the benefits of having a portfolio that is spread across a number of different asset types such as shares, bonds, property and other assets (a diversified portfolio) and one that looks to the long term (generally, 10 years or more).
These portfolios are designed to benefit from the idea that different asset classes tend to perform in different ways in a range of market conditions and losses in one asset class may often be partly balanced with gains in another.