Inflation has been so low of late that its hardly been worth worrying about. But in some markets inflation expectations are rising. Unfortunately, this isn’t accompanied by strong growth. It’s been a while since this was talked about, but could we be heading towards a stagflationary environment?
What is stagflation?
Stagflation is a term that was created in 1965 by Iain Macleod, a British politician; it is a combination of the words stagnation and inflation. Stagflation is used to describe an economic environment where the inflation rate is high and the economic growth rate slow.
Is stagflation happening now?
Currently we’re not facing stagflation, in fact inflation has been incredibly low for a number of years. What is interesting is that inflation is either rising or is predicted to rise in some of the major economies at a time when interest rates around the world are at record lows.
This week UK inflation rose to its highest level in almost two years, the consumer price index is now 1%. This hike in UK inflation is largely attributed to the rising price of oil and increase in clothing prices. The rise in oil price is further exacerbated in the UK by the poor exchange rate of the pound against the dollar.
Interest rates can combat inflation
One way the central banks can work to combat inflation is to increase interest rates. However, low interest rates have become the norm in many large economies since the financial crisis in order to encourage growth. This has had limited impact on growth, and the central banks have adopted quantitative easing measures to provide a further boost. Mark Carney, the governor of the Bank of England, has indicated that he’s prepared to live with above target inflation in order to encourage growth in the UK economy. But UK savers now face an environment where the base interest rate is 0.75% lower than inflation.
Inflation in the Eurozone is currently sat at just 0.4%, this is whilst the base interest rate is 0%, and the European Central Bank targets 2% inflation. That means if you have money sat in cash it would be losing value year-on-year. In March the European Central Bank cut borrowing costs and expanded its quantitative easing programme in an unprecedented package of growth boosting measures.
Diversification is a key driver of performance
When facing a stagflationary environment diversification becomes increasingly important for investors. That’s diversification in terms of asset class, currency and territory; a truly global portfolio enables investors to benefit from growth elsewhere in the markets.
With low growth it is difficult for central banks to raise interest rates, making it harder for individuals to save and harder to make money. Investors could benefit from exposure to inflation indexed bonds in this environment to help protect their wealth.
As inflation starts to rise economic growth indicators will become increasingly important; investors need to pay attention to the gross domestic product, wage expectations, and unemployment. If inflation is rising but wages are staying the same, consumers will continue to struggle.
