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Monday 16 May 2011
Telegraph.co.uk Home News Sport Finance Comment Blogs Culture Travel Lifestyle Fashion Tech Jobs Dating Offers Companies Comment Personal Finance Economics Markets Your Business Olympics Business Business Club Money Deals Ambrose Evans-Pritchard Jeff Randall Damian Reece Jeremy Warner Richard Fletcher Kamal Ahmed Alistair Osborne James QuinnLiam Halligan
Spectre of stagflation reappears as the excesses of QE hit home Between January and March, we now know, the UK economy grew only 0.5pc. Oil prices may have tumbled but crude remains well above $100 a barrel, helping to fuel inflation Photo: Bloomberg News By Liam Halligan, Economic Agenda 5:24PM BST 14 May 2011Comments
This followed the previous quarter's 0.5pc contraction. While presenting its quarterly Inflation Report last week, the Bank of England also downgraded its 2011 growth forecast from 2pc to 1.75pc, while suggesting that the squeeze on household incomes, currently the worst in around 80 years, is set to continue.
Just as UK output is looking shaky again, prices are cranking up – another reason, of course, why real incomes are falling. Consumer price inflation grew 4pc during the year to April – more than double the Bank's "target". The much more accurate RPI measure rose 5.3pc.
It's not just the UK experiencing this sickening combination of sluggish growth and rising prices. New figures suggest US first-quarter growth was also feeble, with America expanding just 0.4pc.
The Federal Reserve, meanwhile, while scaling back official growth forecasts, has just raised its 2011 inflation prediction range to 2.1pc-2.8pc. In April, consumer inflation in the States reached 3.2pc, the highest figure since October 2008.
Rising inflation and stagnating growth raises the spectre of 1970s-style "stagflation". Banished for decades from the lexicon of economists, this ugly word is now re-entering the mainstream. As well as bringing misery on Western households, looming stagflation also has the capacity to seriously spook Western, and ultimately global, financial markets.
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The Western world, by a very long way, has yet to recover from the economic fall-out sparked by the sub-prime debacle. With recovery still fragile in the US and across much of Europe, there are real fears that, unless commodity markets ease very significantly, higher fuel prices will feed into almost all other goods – not only food, but also non-perishable manufactured products and services too. Such a scenario, combined with weak growth, could tip us into a confidence-sapping stagflationary spiral.
Last week, the Bank of England predicted UK CPI inflation could reach 5pc by the end of 2011 – driven by further increases in household gas and electricity bills. Inflation will fall back to its 2pc target in two years' time, the Bank said, only if interest rates are raised five times, beginning in the third quarter of this year.
This is a troubling scenario, not least for the UK's debt-soaked consumers and mortgage-holders. Yet the reality could be even worse given price pressures in the pipeline. In April, after all, UK Input PPI inflation (the input prices of materials and fuels purchased by Britain's manufacturing industry) was up a staggering 17.6pc.
This clearly had a lot to do with commodity prices. But tight commodity markets are a reality. They cannot be wished away, whatever statistical tricks are pulled. Price pressures that we face are anyway much broader. The UK's core output price index, which excludes food & energy, rose 3.4pc in April, up from 3.1pc the month before. This is an incredibly high level – given weak growth during the first quarter, weakness that continued, according to private sector surveys, into last month as well.
I'm not saying UK inflation is set to reach 20pc or even higher, as it did during the dark days of the mid-1970s. Back then, price pressures were compounded by hopelessly rigid labour markets, held to ransom by Neanderthal trade unionists who, as long as they were "all right, Jack" cared not a jot for the broader economy. Apart from one or two living relics, such aggressive wage-pumping tactics (one hopes) are largely behind us.
I see lots of reasons, though, why even the CPI, which seriously understates the true inflation we all experience, could reach 6pc or 7pc in the relatively near future – high enough to seriously curtail investment and, therefore, job growth, while baking-in potentially self-fulfilling expectations that inflation could go higher still.
Numerous "heavy-weight" economists, on reading this, will no doubt accuse me of being "mad" or an "inflation nutter". They said the same thing two years ago when they were all predicting deflation and I was insisting that price pressure – and even stagflation – was the true danger we faced.
Such "respected" economists will tell you that inflation will calm down because there is a lot of "slack" or "spare capacity" in the UK economy, as we recover from the deepest slump in generations. That means, we are told, that future increases in demand, originating from a grotesquely expanded base money supply, say, will feed into output and not prices.
If only that were so. Yes – UK unemployment is relatively high but lots of our jobless are unskilled, institutionally de-motivated and, tragically, for themselves and their country, unemployable. At the same time, while the credit crunch has closed down lots of firms, many of those that have survived have only done so because they sold off capital goods, permanently undermining productive capacity. These are just some of the reasons why the "spare capacity" argument for low future inflation is an intellectual conceit.
"Respected" economists might also argue that the emerging markets will save us from stagflation because they are now growing quickly, so keeping the global economy buoyant.
Having followed emerging markets rather closely for my entire adult life, I agree that they are fast-growing and that, save for occasional vol
Liam Halligan
Comments
This followed the previous quarter's 0.5pc contraction. While presenting its quarterly Inflation Report last week, the Bank of England also downgraded its 2011 growth forecast from 2pc to 1.75pc, while suggesting that the squeeze on household incomes, currently the worst in around 80 years, is set to continue.
Just as UK output is looking shaky again, prices are cranking up – another reason, of course, why real incomes are falling. Consumer price inflation grew 4pc during the year to April – more than double the Bank's "target". The much more accurate RPI measure rose 5.3pc.
It's not just the UK experiencing this sickening combination of sluggish growth and rising prices. New figures suggest US first-quarter growth was also feeble, with America expanding just 0.4pc.
The Federal Reserve, meanwhile, while scaling back official growth forecasts, has just raised its 2011 inflation prediction range to 2.1pc-2.8pc. In April, consumer inflation in the States reached 3.2pc, the highest figure since October 2008.
Rising inflation and stagnating growth raises the spectre of 1970s-style "stagflation". Banished for decades from the lexicon of economists, this ugly word is now re-entering the mainstream. As well as bringing misery on Western households, looming stagflation also has the capacity to seriously spook Western, and ultimately global, financial markets.
Why a tight belt is the best way to strangle inflation
The wrong kind of inflation
Inflation: on the rise again
IFS: families have lost £500 over last 12 months
Bank of England's Inflation Report makes unpleasant reading
UK growth to slow and prices to rise, BoE warns
Oil prices have tumbled from recent highs, but crude remains well above $100 a barrel. Sharp rises in the price of food are also causing pain, and even civil unrest, in many emerging economies.
The Western world, by a very long way, has yet to recover from the economic fall-out sparked by the sub-prime debacle. With recovery still fragile in the US and across much of Europe, there are real fears that, unless commodity markets ease very significantly, higher fuel prices will feed into almost all other goods – not only food, but also non-perishable manufactured products and services too. Such a scenario, combined with weak growth, could tip us into a confidence-sapping stagflationary spiral.
Last week, the Bank of England predicted UK CPI inflation could reach 5pc by the end of 2011 – driven by further increases in household gas and electricity bills. Inflation will fall back to its 2pc target in two years' time, the Bank said, only if interest rates are raised five times, beginning in the third quarter of this year.
This is a troubling scenario, not least for the UK's debt-soaked consumers and mortgage-holders. Yet the reality could be even worse given price pressures in the pipeline. In April, after all, UK Input PPI inflation (the input prices of materials and fuels purchased by Britain's manufacturing industry) was up a staggering 17.6pc.
This clearly had a lot to do with commodity prices. But tight commodity markets are a reality. They cannot be wished away, whatever statistical tricks are pulled. Price pressures that we face are anyway much broader. The UK's core output price index, which excludes food & energy, rose 3.4pc in April, up from 3.1pc the month before. This is an incredibly high level – given weak growth during the first quarter, weakness that continued, according to private sector surveys, into last month as well.
I'm not saying UK inflation is set to reach 20pc or even higher, as it did during the dark days of the mid-1970s. Back then, price pressures were compounded by hopelessly rigid labour markets, held to ransom by Neanderthal trade unionists who, as long as they were "all right, Jack" cared not a jot for the broader economy. Apart from one or two living relics, such aggressive wage-pumping tactics (one hopes) are largely behind us.
I see lots of reasons, though, why even the CPI, which seriously understates the true inflation we all experience, could reach 6pc or 7pc in the relatively near future – high enough to seriously curtail investment and, therefore, job growth, while baking-in potentially self-fulfilling expectations that inflation could go higher still.
Numerous "heavy-weight" economists, on reading this, will no doubt accuse me of being "mad" or an "inflation nutter". They said the same thing two years ago when they were all predicting deflation and I was insisting that price pressure – and even stagflation – was the true danger we faced.
Such "respected" economists will tell you that inflation will calm down because there is a lot of "slack" or "spare capacity" in the UK economy, as we recover from the deepest slump in generations. That means, we are told, that future increases in demand, originating from a grotesquely expanded base money supply, say, will feed into output and not prices.
If only that were so. Yes – UK unemployment is relatively high but lots of our jobless are unskilled, institutionally de-motivated and, tragically, for themselves and their country, unemployable. At the same time, while the credit crunch has closed down lots of firms, many of those that have survived have only done so because they sold off capital goods, permanently undermining productive capacity. These are just some of the reasons why the "spare capacity" argument for low future inflation is an intellectual conceit.
"Respected" economists might also argue that the emerging markets will save us from stagflation because they are now growing quickly, so keeping the global economy buoyant.
Having followed emerging markets rather closely for my entire adult life, I agree that they are fast-growing and that, save for occasional volatility, this is likely to continue. But are we engaging with them as much as we should? I don't think so. The West can't even bring itself to make the concessions needed to complete the trade liberalising "Doha round" – which would allow us to seriously get involved in, and do business with, the world's most dynamic economies. So we are failing to benefit as we could from the growth that is taking place elsewhere, while being unable to avoid, of course, the implications of that growth on global commodity markets.
Today's high oil prices, unlike the OPEC-induced price shocks of the 1970s, reflect rising demand from the East far more than concerns about supply.
With the world's population due to expand from 6.5bn to 9bn in the next 20 years, and per capita energy-use spiralling ever upward, is there any doubt that commodity prices are locked in an upward-trending super-cycle? Speculative pressures mount, and then unwind. But the direction of travel is clear.
I'm not saying that Western policymakers have any easy options. I do feel, though, that we've made a bad situation worse. There was, perhaps, an argument for limited quantitative easing in the aftermath of the credit-crunch – provided the newly created liquidity was used to "transition" and restructure our bloated, insolvent, banking system, with losses having been declared. That could have resulted in QE genuinely kick-starting lending, by restoring trust among various inter-bank market participants.
Rather than a one-off buffer, though, allowing us to purge and renew, QE has instead been used as a veil, allowing the grotesque banking cover-up to continue.
Losses are being imposed on Western savers in the form of current and future inflation with no compensating gains whatsoever in terms of bank restructuring or enhanced lending. Losses are being imposed on creditors to Western governments too.
The Western world has barely begun to feel the inflationary impact of QE. In my view it will quite soon. We face a serious bout of inflation – nay stagflation. Enduring it will be made worse by the knowledge that it will be at least partly self-imposed.
• Liam Halligan is chief economist at Prosperity Capital Management
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