The three chords of stagflation

We need a Boogie Rock revival about as much as we do stagflation. And with Status Quo embarking on another ‘last tour’ to promote their latest release, Acoustic II, I’m not sure whether to be more concerned for our ears or our earnings…

2 November 2016

Status Quo’s return to the stage will no doubt bring much nostalgic joy to the Boomers who grew up head-banging their way through the 70s to Parfitt and Rossi. Alas, the three-chord maestros left me cold. Instead, I can’t help but remember the skyrocketing price for pop and sweets, and helping my father constantly re-price goods in his store as stagflation hit Britain.

So with growth slowing and inflation flaring up, are we on the cusp of another period of low growth, soaring prices and high unemployment?

The latest National Institute for Economic and Social Research (NIESR) report, released Tuesday, predicts 4% inflation in 2017. This paper could have been called ‘Stagflation II’. (For me, listening to the Quo’s greatest hits belted out at the Bournemouth International Arena would be as painful as stagflation.)

I know what you’re thinking: Stagflation with inflation at 4%? Really? Surely stagflation’s inflation in the high teens or twenties, as those of us of a certain age will remember. It rose above 25% during the decade of the flare.

Actually, the definition of stagflation is slow economic growth and relatively high unemployment accompanied by rising prices.

I have underlined three key words to explain my thinking.  Stagflation isn’t necessarily economic contraction, but could mean slow growth; not extremely high unemployment but ‘relatively’; and not skyrocketing prices, just rising.

So let’s look at the evidence.

There is slow economic growth across the developed world. Brexit brings the risk of even slower domestic growth in the UK, while the possibility of a protectionist Trump presidency may result in slower global growth. So a tick here, potentially.

Unemployment is relatively low in the UK at the moment. Brexit certainly brings the risk of rising unemployment if the private sector starts to decamp for sunnier climes of the eurozone. So a cross for now, but there’s a risk it could become a tick over the next two years. Wage growth is currently non-existent in the UK, so does this have a similar impact on consumers as rising unemployment? Maybe a half-tick?

Rising prices – big tick. Whether it’s Marmite, Apple iPhones or a litre of diesel, the fall in sterling is clearly having an inflationary impact in the UK.

My conclusion: 4% inflation would be stagflation, given its effect on real earnings. The retro rise of stagflation has not really hit mainstream thinking yet, but we have been mulling it for a while.

We’re looking for ways to mitigate this potential risk – please note ‘potential’, not ‘probable’.

How would we do this? Inflation-linked bonds, commodities and companies that generate non-cyclical structural growth, i.e. those with pricing power.

Nothing new, but a retro risk needs a retro solution.