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Stagflation fears intensify in signs of slowing growth

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Provide chain disruptions sweeping main economies have reawakened an previous nemesis for traders: stagflation.

Anxiousness over rising inflation has been ever-present in markets this 12 months. However with oil topping $80 a barrel, world meals costs a 3rd dearer than they have been a 12 months in the past and different commodities at decade highs, traders say a longer-than-expected inflationary surge is coinciding with a slowdown in development — and making it worse.

Economists and traders play down comparisons with the aftermath of the Seventies oil shock, which gave rise to the time period “stagflation”. Then, inflation and rates of interest bumped into double digits, unemployment soared and GDP recovered solely slowly from repeated setbacks.

However with power payments now rocketing, many fear a couple of development slowdown at a time when central banks are edging in the direction of lifting rates of interest in a bid to maintain a lid on longer-term inflation.

“The dialog round inflation has undoubtedly shifted,” mentioned Seema Shah, chief strategist at Principal World Traders. “There’s nonetheless a broad settlement that a variety of it’s transitory, however we nonetheless assume it is going to final effectively into 2022 and actually begin to hit shopper spending.”

“It’s not the Seventies, however that is modern-day stagflation.”

Line chart of Annual % change in consumer prices  showing Inflation has risen faster than expected across developed economies

Alerts from the Federal Reserve and Financial institution of England final week that they might quickly start lifting charges have fuelled a big bond sell-off over the previous week and a half. However in distinction to the “reflation” commerce at the beginning of this 12 months, shares have been unable to attract consolation from the prospect that tighter financial coverage can be accompanied by accelerating development.

Ample proof means that the provision shock reverberating all over the world, mixed with outbreaks of the Delta variant of coronavirus, is tempering the restoration in development.

Information launched this week pointed to a pointy slowdown in Chinese language manufacturing, as regulatory pressures and excessive power costs shut down some manufacturing. Enterprise surveys from the US, UK and eurozone recommend that exercise has slowed as supply instances lengthened and backlogs constructed up.

Line chart of Manufacturing purchasing Managers Index (Above 50 = a majority of businesses reporting expansion) showing Business surveys suggest the global recovery is now losing momentum

Promoting exercise spilled over into fairness markets this week after knowledge confirmed that US shopper confidence had dropped to a six-month low in August.

The UK has discovered itself on the sharp finish of stagflationary considerations, with a surge in power costs compounded by driver shortages that left petrol pumps working dry.

Whereas revised knowledge present exercise bounced again sooner than thought over the summer season, the restoration now seems to be faltering. The Financial institution of England’s governor Andrew Bailey acknowledged this week that offer bottlenecks and labour shortages have been worsening, and will maintain down development and gas inflation for some months to return.

“The restoration has slowed and the economic system has been buffeted by extra shocks,” he mentioned in a speech to the Society for Skilled Economists.

Considerations over development are one purpose the pound has not benefited from a pointy rise in UK authorities bond yields, as they sometimes do, after Bailey signalled {that a} price rise might come as quickly as this 12 months. As an alternative, sterling has slumped to its lowest stage of 2021 in opposition to the greenback, as some traders concern that early price will increase might choke off a fragile restoration.

“Whether it is stagflation, central banks are in a bind,” mentioned Jim Leaviss, head of public fastened earnings at M&G Investments. “Climbing will scale back demand slightly bit and strengthen the foreign money. However it is going to don’t have any impression on provide chain points [ . . .] it received’t carry again lorry drivers.”

That dilemma — shared by different massive central banks — might threaten buoyant fairness markets, based on Mohamed El-Erian, chief financial adviser at Allianz.

“Central banks can be torn between reacting to the ‘stag’ and the ‘flation’,” he mentioned. “That’s a world the place traders’ confidence in policymakers is shaken, and the backstop they’ve had over the previous decade isn’t there any extra.”

Vicky Redwood, senior financial adviser at consultancy Capital Economics, mentioned the UK’s “stagflation lite” was seen in lots of nations — with the surge in inflation coming earlier within the US, however development now slowing there too because of the unfold of the Delta coronavirus variant.

However inflation ought to begin to ease in 2022 and the scenario was nonetheless “a great distance off something just like the Seventies,” she mentioned, including: “we received’t see inflation get into the system like we did then.”

Others warn, nonetheless, that there isn’t any signal but of the strains on provide chains easing, and that the world might be heading for a extra sustained interval of tepid development and better inflation than policymakers have been predicting.

“It’s a world drawback,” mentioned Kallum Pickering, economist at Berenberg, arguing that firms had little visibility over “very difficult provide chains” and disruption might final for much longer than thought.

If provide chain issues continued for an extra six to 12 months, whereas shoppers nonetheless had job safety and have been prepared to pay for the products they wished, he mentioned: “the whiff of stagflation may be extra of a stench”.

Extra reporting by Federica Cocco 

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