Stagflation fears intensify in signs of slowing growth

Economists have played down comparisons with the 1970s oil shock

Tommy Stubbington and Delphine Strauss in London 

The UK is at the sharp end of stagflationary concerns, with driver shortages compounding a surge in energy prices © Peter Nicholls/Reuters

Supply chain disruptions sweeping major economies have reawakened an old nemesis for investors: stagflation.

Anxiety over rising inflation has been ever-present in markets this year. 

But with oil topping $80 a barrel, global food prices a third more expensive than they were a year ago and other commodities at decade highs, investors say a longer-than-expected inflationary surge is coinciding with a slowdown in growth — and making it worse.

Economists and investors play down comparisons with the aftermath of the 1970s oil shock, which gave rise to the term “stagflation”. 

Then, inflation and interest rates ran into double digits, unemployment soared and GDP recovered only slowly from repeated setbacks.

But with energy bills now rocketing, many worry about a growth slowdown at a time when central banks are edging towards lifting interest rates in a bid to keep a lid on longer-term inflation.

“The conversation around inflation has definitely shifted,” said Seema Shah, chief strategist at Principal Global Investors. 

“There’s still a broad agreement that a lot of it is transitory, but we still think it will last well into 2022 and really start to hit consumer spending.”

“It’s not the 1970s, but this is modern-day stagflation.”

Signals from the Federal Reserve and Bank of England last week that they could soon begin lifting rates have fuelled a big bond sell-off over the past week and a half. 

But in contrast to the “reflation” trade at the start of this year, stocks have been unable to draw comfort from the prospect that tighter monetary policy will be accompanied by accelerating growth.

Ample evidence suggests that the supply shock reverberating around the world, combined with outbreaks of the Delta variant of coronavirus, is tempering the recovery in growth.

Data released this week pointed to a sharp slowdown in Chinese manufacturing, as regulatory pressures and high energy prices shut down some production. 

Business surveys from the US, UK and eurozone suggest that activity has slowed as delivery times lengthened and backlogs built up.

Selling activity spilled over into equity markets this week after data showed that US consumer confidence had dropped to a six-month low in August.

The UK has found itself at the sharp end of stagflationary concerns, with a surge in energy prices compounded by driver shortages that left petrol pumps running dry.

While revised data show activity bounced back faster than thought over the summer, the recovery now appears to be faltering. The Bank of England’s governor Andrew Bailey acknowledged this week that supply bottlenecks and labour shortages were worsening, and could hold down growth and fuel inflation for some months to come.

“The recovery has slowed and the economy has been buffeted by additional shocks,” he said in a speech to the Society for Professional Economists.

Concerns over growth are one reason the pound has not benefited from a sharp rise in UK government bond yields, as they typically do, after Bailey signalled that a rate rise could come as soon as this year. 

Instead, sterling has slumped to its lowest level of 2021 against the dollar, as some investors fear that early rate increases could choke off a fragile recovery.

“If it is stagflation, central banks are in a bind,” said Jim Leaviss, head of public fixed income at M&G Investments. 

“Hiking will reduce demand a little bit and strengthen the currency. 

But it will have no impact on supply chain issues [ . . .] it won’t bring back lorry drivers.”

That dilemma — shared by other big central banks — could threaten buoyant equity markets, according to Mohamed El-Erian, chief economic adviser at Allianz.

“Central banks will be torn between reacting to the ‘stag’ and the ‘flation’,” he said. “That’s a world where investors’ confidence in policymakers is shaken, and the backstop they’ve had over the past decade isn’t there any more.”

Vicky Redwood, senior economic adviser at consultancy Capital Economics, said the UK’s “stagflation lite” was visible in many countries — with the surge in inflation coming earlier in the US, but growth now slowing there too as a result of the spread of the Delta coronavirus variant.

But inflation should start to ease in 2022 and the situation was still “a long way off anything like the 1970s,” she said, adding: “we won’t see inflation get into the system like we did then.”

Others warn, however, that there is no sign yet of the strains on supply chains easing, and that the world could be heading for a more sustained period of tepid growth and higher inflation than policymakers have been predicting.

“It’s a global problem,” said Kallum Pickering, economist at Berenberg, arguing that companies had little visibility over “very complicated supply chains” and disruption could last much longer than thought.

If supply chain problems continued for a further six to 12 months, while consumers still had job security and were willing to pay for the goods they wanted, he said: “the whiff of stagflation might be more of a stench”.

Additional reporting by Federica Cocco  

Can Chile’s constitutional convention defuse people’s discontent?

The reasons for massive protests in 2019 have not entirely gone away

The presidential election due in November will be like no other in Chile since the restoration of democracy in 1989. 

That is partly because the leading candidates are fairly new faces, and the Concertación, the centre-left alliance that dominated most of that period, is no more. 

But it is mainly because the winner will at first cohabit with a convention which is writing a new constitution and which could decide to curtail the normal four-year presidential term. 

All this is because Chile is still picking up the pieces after an explosion of massive and sometimes violent protests in late 2019 that shook what had been one of Latin America’s most stable and seemingly successful countries.

At the heart of the protests was anger over narrowing opportunities and inadequate and unequal access to health care, pensions and education. 

The convention was offered by a discredited political class in November 2019 to provide a peaceful path out of a dangerous conflict. 

It seems certain to move Chile to the left. 

The question is how far.

The initial answer seemed to be a long way. 

At an election for the convention in May, in which only 43% of the electorate voted, the far left won 55 of the 155 seats (of which 17 were reserved for representatives of indigenous peoples). 

The election was a defeat for both the former Concertación (25 seats) and the right (37). 

Many of the representatives are, nominally at least, independents in an election where to be new, young and untested by politics-as-usual was a winning formula.

Now that the convention has sat for almost three of its allotted maximum of 15 months, and has accomplished little beyond approving its own rules this week, it is starting to moderate. 

One far-left group has imploded, its credibility destroyed when one of its leaders admitted that his claim to be a cancer-sufferer denied proper health care was false. 

Another has split: the Broad Front (fa, for its initials in Spanish) has fallen out with the Communist Party. 

One poll shows approval of the convention falling to 30%.

But its serious work is only just starting. 

“We’re discussing issues that affect deeply rooted interests and power centres,” says Patricia Politzer, a centrist independent representative. 

“It was never going to be easy.” 

She is part of a broad dealmaking nucleus that is starting to emerge. 

They are likely to become increasingly influential as the convention grapples with the big issues. 

First, it is certain to define as constitutional rights a long list of expensive things, such as pensions and housing. 

The issue is whether these will be enforceable in the courts, or left to secondary laws. 

The second question is whether Chile will move to a semi-parliamentary system, as part of an effort to diffuse power. 

Third, the new document seems certain to impose stricter environmental standards. 

Much will depend on whether the final text embodies a sense of fiscal realism and a recognition of the need for a vigorous market economy to generate prosperity and finance better public services.

The presidential election may give a clearer sense of Chile’s change of course. 

The front-runner is Gabriel Boric, a 35-year-old fa leader. 

He defeated a Communist in a primary. 

His economic programme is radical. 

But it seeks to turn Chile into something more like Germany than Venezuela, with European levels of tax and green investment, state companies and industrial policy. 

Whether this could work quickly in Chile is doubtful.

Mr Boric may face Sebastián Sichel of the centre-right in the inevitable run-off, in December. 

But alternatively this might feature José Antonio Kast of the hard right. 

Mr Kast appeals to the large silent minority who were scared by the violence of the protests and fear instability. 

Were he to win he would surely clash with the convention.

The election will show whether the convention represents a snapshot of a moment of rage in 2019 that is starting to fade (partly because of the pandemic), or whether it is part of a continuing demand for radical change. 

There is evidence for both possibilities. 

A recent poll by the Centre for Public Studies, a think-tank, showed an improving view of Chilean democracy and crime displacing pensions as the top public concern. 

Only 39% now say they wholeheartedly supported the protests, compared with 55% in the same poll in December 2019. 

But discontent remains. “People are not on the streets now because they place their hopes in the convention,” says Ms Politzer. 

The presidential contest will thus be a battle between hope and fear.

Productivity growth is almost everything in the post-Covid recovery

Being more productive will help keep prices stable even in the face of higher wages

Megan Greene

Workers make pods for the e-cigarette company Myst Labs on the production line at First Union, one of China’s leading manufacturers of vaping products © Kevin Frayer/Getty

The great inflation debate — is it sustained or transitory? — is missing a piece: productivity growth. 

The ability to produce more with the same or fewer inputs “isn’t everything”, Nobel Prize-winning economist Paul Krugman says, “but in the long-run it is almost everything”. 

It is likely that productivity growth has accelerated during the pandemic, which should take upward pressure off prices. 

It could also raise the long-run neutral interest rate for the world’s largest economies, giving their central banks more room to manoeuvre than we appreciate.

Most economists will tell you it is virtually impossible to have sustained price increases without spiralling wage growth. 

As Pantheon Macroeconomics highlighted in a recent client note, the single best indicator of consumer price inflation is unit labour costs. 

They have two inputs: wages and productivity. 

Because productivity growth tends to be stable, most economists look at wages as a rough measure of unit labour cost growth.

Wage growth has clearly accelerated during the pandemic, though this data has been distorted by compositional effects (as lower-wage hourly service workers lost jobs, aggregate wages rose). 

Nevertheless, with job openings surging and unemployment still higher than before the pandemic, firms are offering higher wages to fill roles. 

Production and non-supervisory workers in the US saw average hourly earnings almost 5 per cent year-on-year in July and August.

If productivity also accelerates, however, unit labour costs should remain stable and so should prices. 

After averaging around 1 per cent annual growth from 2013-18 in the US, eurozone and UK, labour productivity growth in those regions has roughly doubled in recent years. 

In the US, it grew an average of 3 per cent in the first half of 2021. 

Unit labour costs fell 0.8 per cent during the same period.

While a productivity bump is a standard feature of early stage recoveries, there are signs this one will last. 

A McKinsey Global Economic Conditions survey of executives at the end of 2020 showed just over half of respondents in North America and Europe said they had increased investment in new technologies over the year and about 75 per cent said they expected investment in new technologies to accelerate in 2020-24. 

Companies digitised activities 20-25 times faster than they had previous thought possible.

New orders for US-manufactured durable goods, a forward-looking gauge of investment, have risen in 15 of the past 16 months. 

There are many reasons to believe firms will continue to invest: they are sitting on a mound of cash as a result of stimulus programmes and cheap credit, earnings growth has soared, labour is no longer such a cheap substitute for capital expenditure and firms have to catch up after weak investment in the previous cycle.

The shift to working from home during the pandemic also may have yielded efficiency gains. 

According to a forthcoming survey of over 375 firms and $21tn in market capitalisation, by World50, 65 per cent of respondents felt remote working had been good for productivity. 

The jury is still out on this: bosses may see higher output without appreciating the expanded number of hours employees are putting in at home.

Higher productivity growth allows the economy to maintain stable prices even in the face of higher wages. 

Reopening the global economy has created supply shortages that have lifted inflation. 

As output rises, with productivity higher, those costs should fall. 

Companies will be able to afford higher wages without compressing margins.

Governments are embracing the concept that productivity growth is a good thing. 

The Biden administration is trying to pass $3.5tn in spending on infrastructure and investment in human capital. 

Deployed over the next decade, this would underpin continued US productivity growth over the long term. 

The eurozone’s €806bn Next Generation EU Fund requires a significant percentage to be spent on digitisation, research and innovation.

That should boost potential growth, and therefore the long-run interest rate that maximises growth without triggering inflation will be higher. 

The Federal Reserve’s latest projections estimate this rate to be 2.5 per cent. 

If productivity continues to rise, this rate will as well. 

Markets may balk at higher potential rates, but the central bank will have more flexibility to continue its efforts to drive unemployment lower. 

To boost growth, minimise inflation and maximise welfare, productivity is indeed almost everything.

The writer is a senior fellow at Harvard Kennedy School.