On Tuesday, the U.K. clocked in its highest level of inflation on record. Unfortunately, many traders took the report as bearish for the economy. And why not? The latest economic reports certainly suggest that the U.K. economy is experiencing stagflation.
Unless you had a habit of sleeping through your Economics 101 class, you would remember that stagflation occurs when the economy experiences slow economic growth and high unemployment (stagnation) in a time of rising prices (inflation). Sounds familiar? Let's see if it applies to the U.K. economy.
Slow economic growth? Check.
The National Institute of Economic and Social Research (NIESR) recently estimated that the U.K. economy grew by 0.5% in the third quarter of 2011. Though this number is slightly higher than the final GDP figure of 0.1% in the second quarter, it is still 4% below its pre-recession peaks. This leads analysts to believe that it will take a while before economic growth gains traction.
As a matter of fact, the Bank of England's (BOE) outlook for the economy has turned so grim that it now expects the economy to flat-line over the next three months. No wonder the members of the monetary policy committee voted unanimously to increase stimulus by another 75 billion GBP!
High unemployment? Check.
The unemployment rate in the U.K. rose from 7.9% to 8.1% in August, which is not only consistent with the rising trend that has developed in the past 5 months, but is also a 15-year high. Meanwhile, jobless claims also rose for the seventh consecutive month, registering 17,500 claimants in September.
Inflation? Double check.
You can't have stagflation without inflation. In the U.K.'s case, there's no shortage of it. Inflationary pressures have been persistently strong and stubborn in the U.K. Heck, the CPI hasn't fallen below the BOE's target of 2% since 2009!
Just last month, we saw the index jump from 4.5% to reach a record high of 5.2%. The details of the report reveal that gas and electricity prices played a big role in the surge in prices, as they posted a 10.2% rise month on month!
In my opinion, the BOE is stuck between a rock and a hard place as it has the unenviable task of boosting economic growth without triggering a further rise in prices. Even the markets are starting to acknowledge the central bank's dilemma. They sold the pound on Tuesday even though the U.K. printed ridiculously strong inflation data.
So is stagflation the name of the game? Recent data seems to suggest it, but I think we'll need a couple months' worth of data to determine whether or not stagflation has truly set in.
Right now, the only thing I can say with conviction is that I would hate to be in the BOE's shoes, and that the pound will probably face considerable headwinds if this trend of weak growth, high unemployment, and strong inflation continues.
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