What does Stagflation mean for the UK economy?

The UK data over the last month has presented a contradictory image. The second quarter saw a faster growth than anticipated, while consumer confidence has increased. Public borrowing was also lower than expected due to strong tax revenues.

Sales were down and unemployment is on the rise.

Diverging trends in the market have led to confusion, resulting in fluctuating bond rates and interest rate forecasts. After wage increases were reported earlier in December, the two-year bond yield and expectations for December rates quickly increased. However, they fell again after underwhelming indicators.

What’s the story?

The economic rollercoaster is due to stagflation. This refers to a period when there’s high inflation and a stagnant economy. This can cause measures that have not been adjusted for inflation to rise rapidly.

In the UK, wages rose at the fastest rate ever recorded in the three-month period ending in June. This trend, as well as the high number of job-to-job transfers, reflects workers’ attempts to minimize the financial impact that high inflation and rising rates will have on their finances.

While isolating, the price of goods rose by 6.8% annually in July. This was more than three-times the Bank of England target of 2%.

The total wage is up by 21 percent in cash terms from the quarter ending February 2020. However, when adjusted for inflation, they remain largely unchanged. This strong wage growth is likely to have contributed to the 5-point rise in UK consumer Confidence in August.

Paul Dales, chief UK economist of Capital Economics, said: “During a stagflation period, you would expect nominal/cash indicators — such as wage and tax revenue — to rise by more than actual indicators, such the PMIs or real gross national product, or real gross product growth.”

The Office for Budget Responsibility (UK fiscal watchdog) predicted that borrowing would be 17 percent less in the first four month of the current fiscal.

Victoria Scholar, the head of Interactive Investor’s online investment service, stated that high inflation has “benefited” government finances.

Scholar explained that “inflation tends provide a boost in government tax receipts as it pushes earners to higher tax brackets. This is especially true with wage growth at record levels.”

Thomas Pugh of RSM UK, an economist, said that the combination of high unemployment — which increases VAT and corporate taxes — and high wages — which increases income, national insurance, and flat tax allowances, “tells us very little about the actual state of the economy.”

UK Economy has stagnated since 2021, and is actually smaller in the last three months of 2019. The UK economy is still growing despite the fact that wholesale energy prices have dropped and government assistance to households and businesses has been extensive.

James Smith, Research Director at the Resolution Foundation, said: “We are witnessing an economy that is experiencing a large terms-of trade shock”. He was referring to a period in which British imports were much more expensive than British exports after Russia’s invasion into Ukraine, and increased trade barriers between the EU and Britain following Brexit.

Smith claims that this “shock”, as he calls it, led to a rapid increase in wages and prices. Interest rates also rose.

He said that the combination of these factors is beginning to have an impact on the real economy.

The unemployment rate has already risen to 4.2% in the last three months. This is the highest level in almost two years.

Between June and July, mortgage approvals fell by almost 10 percent. Retail Sales also disappointed last month, dropping by 1.2 percent compared to the previous month. This may be due to unusually wet conditions rather than a weakness in consumer demand.

The tumbling pmi was the real alarming sign. It indicated that activity had declined in both manufacturing and services in August.

Analysts say that PMIs do not conflict with official economic statistics which are more positive and published with a greater time delay. Instead, they are closer to indicators of real-time.

The most recent PMIs, according to economists, suggest that interest rates have begun to impact economic activity. The BoE will likely increase interest rates at its next monetary meeting in September for the 15th time consecutively since December 2021. The benchmark rate of the central bank is now at 5.25 percent, which is a 15-year record.

This could slow down the economy and reverse the recent positive data on wages and public finances.

Dales said that if the PMIs indicate that the economy will be heading into a mild recession as we anticipate, this would eventually lead to a slower growth in wage and tax revenue.