UK economy: Stagflation concerns persist after worrying week
Towards the end of 2024 one word captured fears among analysts about the future of the UK economy: stagflation.
Stagflation is an unusual combination of high inflation and weak growth. After all, prices should not be rising fast when the economy is under-performing, because people have less money to spend.
But data out this week suggested that concerns about stagflation have not yet fallen off the agenda:
- Wage growth accelerated, putting extra costs onto businesses, even though unemployment picked up and the number of payrolled employees fell at its fastest pace since November 2020.
- Two surveys showed consumer confidence continued to fall in January, driven by concerns about the health of the wider economy.
- The ‘flash’ PMI improved slightly on December, but the survey also showed job losses picking up and cost pressures accelerating at the fastest pace in one-and-a-half years.
So how concerned should the UK be?
There’s no doubt that inflationary pressures in the UK economy are not yet entirely under control.
Tuesday’s labour market figures showed that regular pay growth averaged 5.6 per cent in the three months to November, up from 5.2 per cent previously.
Most economists think that pay growth needs to be nearer three per cent to be consistent with the two per cent inflation target on a consistent basis.
It is true the pay growth figures were exaggerated by so-called base effects, which reflect the impact of the starting point for the annual comparison.
Policymakers try and strip out the influence of these statistical quirks. Using real time data, analysts at Oxford Economics think pay growth has stabilised around 4.5 per cent.
This is still too high for rate-setters to be comfortable, even if it is markedly better than the official figures. The latest PMI will have only added to fears about sticky inflation, however.
Input prices increased at the fastest pace in one-and-a-half years on the back of more expensive raw material and rising energy prices, as well as higher salary costs.
This forced firms to pass on higher costs to consumers, with output price inflation rising at its fastest pace since July 2023.
Price pressures were particularly prevalent in the services sector. On the basis of the survey, analysts at Capital Economics suggested that services inflation – a crucial gauge of homegrown price pressures – could climb to around 5.0 per cent in six months time.
Waiting on rates and inflation
All of this comes before firms feel the impact of the government’s national insurance hike, which many surveys suggest will lead to higher prices too.
The headline rate of inflation is expected to climb over three per cent by the spring.
Economists are slightly more hopeful that growth will pick up as the year progresses, but the early indicators are not good.
Consumer confidence is at its lowest level in more than a year, according to GfK. Lower confidence will likely stymie growth in consumer spending, at least in the short term.
The PMI suggests that businesses have been slashing jobs over the past two months at the same rate as during the financial crisis.
And while there was a very slight improvement in the PMI, the survey points to a very gradual expansion in the first quarter – at best.
There are problems with each of these surveys, and caveats that could be made, but it is clear that the economy is not firing on all cylinders.
With growth weakening, investors expect the Bank of England to cut interest rates in February, but lingering fears about inflation will prevent the MPC from backing more aggressive cuts.
“The data released this week showing a mix of weaker economic activity but rising price pressures will do little to ease the Bank of England’s policy dilemma,” Alex Kerr, UK economist at Capital Economics said.
Still, most economists think the risk stagflation is fairly remote, even factoring in the impact of April’s national insurance hike.
Goldman Sachs published a note this week which suggested that the Bank could cut rates six times by the middle of next year, partly because they forecast growth to be weak.
The consensus among economists is that firms will not be able to pass on higher costs to consumers while demand remains so weak.
“Ultimately, softness in activity and employment may lead to disinflation further down the track once the price level adjustment to the NICs is complete, as long as inflation expectations remain anchored, which is our expectation,” economists at Barclays said.
But this is of little comfort. Stagnation may be preferable to stagflation, but it is hardly something to celebrate.