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Beware! Stagflation is next

As inflation moves on from food to rising fuel costs (thanks Libya) and then mounting raw material imports, Britain is about to be hammered by the combination of higher prices squeezing consumer spending and higher material costs hurting business profits.

Be prepared for the economy’s ugliest maelstrom: STAGFLATION.

The telltale signs are already there: GDP fell 0.5 per cent last quarter. Unemployment unexpectedly rose in January. Inflation has hit four per cent (and RPI actually rose to 5.1 per cent).

While Mervyn King is busy writing letters to the Chancellor explaining why the Bank of England has still not taken steps to curb inflation, stagflation is making its move.

It’s just senseless that the MPC still hasn’t increased the base rate. What good has keeping it at the historic low of 0.5 per cent for nearly two years done Sure, it’s kept mortgage owners happy, but what good has it done for the economy?

The worry, as MPC member Dr Andrew Sentance has repeatedly pointed out, is that if interest rates don’t begin to rise gradually soon, they may have to do so aggressively in the future, creating a “big shock” to business and consumer confidence.

The good news is that the Bank of England’s Monetary Policy Committee is starting to wake up: three members voted for a rise in the base rate, minutes from the latest meeting show.

While inflation on its own isn’t necessarily a terrible thing, it gets more complicated when coupled with stagnant economic activity. The problem is that traditional economic instruments are counterproductive – you can tackle inflation with higher interest rates, but higher interest rates slow down the economy. Catch 22.

And world events are also making it tougher: for example, the Libya crisis is causing oil prices to soar.

The worry is the prospect of 1970s-style oil shocks. Libya is the world’s 12th largest oil exporter, and the unrest there is causing investors to worry about the possibility of an oil shock similar to the ones that triggered the worldwide stagflation of the 1970s.

Stagflation is notoriously hard for governments to get rid of, and it would cause a serious dent in Britain’s recovery. The Bank of England – and the government – needs to take the lead.

Unfortunately, this isn’t just a macro-economic issue. Small businesses should be worried, as one way or another, over the next six months, British consumers and businesses are doomed to feel the effects. This nasty combination will inevitably slow the economy down and employment will suffer. Welcome to stagflation.



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