The term ‘stagflation’ was first used in Parliament in 1965 by Iain Macleod, a prominent Conservative MP. He told the House of Commons that the country was facing the worst of both worlds: “Not just inflation on the one side or (economic) stagnation on the other, but both of them together. We have a sort of stagflation situation.”
Today, 57 years later, Britain is in another period of surging inflation – stagnation is also a looming threat.
The cost of goods and services has been rising this year. The inflation rate, as measured by the CPI, hit 9.1% in May; the Bank of England is now forecasting that it could reach 11% by Autumn. This is largely the result of soaring energy prices and the disruption of global supply chains caused by the pandemic and the war in Ukraine.
Andrew Bailey, the Bank of England governor, recently said that about 80% of price increases came from abroad. As a consequence, the Bank’s ability to bring inflation down to the 2% target set by government is limited.
However, the Bank did pump £450bn into the economy through quantitative easing. This stimulus scheme, which began in 2008 and was accelerated during the pandemic, boosted the supply of money in the economy, adding to inflationary pressures.
In April UK GDP fell by 0.3%, across its three components – services, production and construction. There is now a strong likelihood that the economy will contract in the second quarter of 2022, heightening the possibility of a recession – which is defined as two consecutive quarters of negative growth.
The combination of rising inflation and slowing economic growth is a major source of anxiety for the Bank. Concern over the spiralling cost of living prompted the Bank’s rate-setting Monetary Policy Committee (MPC) to increase the base rate for the fifth consecutive time in June to 1.25%. But the weakness in the GDP data seems to have limited the rise to 0.25 percentage points, rather than the rumoured 0.50 percentage points.
What will be the Bank’s next move? The MPC’s members are split, with three voting for a 0.50 percentage point rise. Yet if the GDP numbers continue to be negative, the MPC will be far more cautious about further increases. If signs of weakness emerge in the labour market, there may be only one or two more upward moves in the base rate this year. This would leave the rate at 1.5% or 1.75% by the end of 2022.
But if employment continues to be strong, households continue to spend and the GDP numbers are more benign, the MPC may take more aggressive action.
It’s worth noting that April’s 0.4% GDP decline was viewed as something of a blip since it was mostly due to the scaling back of Covid-testing and vaccinations.
In a more aggressive scenario, the base rate could go above 2.0% by Christmas, potentially peaking at 2.5% in 2023.
It would be an understatement to say that the Bank is stuck between a rock and a hard place. Yet some economistscontend that the current fragile stateof the economy is partly a result of interest rates staying too low, for too long.
Many of the current causes of higherinflation seems set to be relativelytemporary – and there is no doubt that the Bank will do everything in its power to curtail a period of stagflation.
Nevertheless, it seems that households are going to be squeezed for a little longer than was thought - perhaps until late 2023.
