Will Stagflation Persist in the UK? EUR/GBP Volatility May Be an Indicator

In recent years, the United Kingdom has found itself mired in a sea of economic uncertainty, prompting widespread speculation about the dreaded 'R-word'—recession.

While the nation has navigated a prolonged cost-of-living crisis marked by noticeable spikes in everyday expenses, mortgage payments, and other essential outlays, it has managed to avert an official recession thus far. However, lurking in the shadows is a different concern: stagflation.

Defining Stagflation

Stagflation, a term often used to describe an economic quagmire characterised by high inflation, low economic growth, and soaring unemployment, has begun to creep into discussions surrounding the UK's economic health. The conflicting signals emanating from the British economic landscape are creating a puzzle that demands careful examination.

Mixed Signals: The Economic Landscape

Over the past month, economic data in the UK has been nothing short of a mixed bag. On the one hand, the economy outpaced expectations in the second quarter, consumer confidence witnessed an uptick, and public borrowing defied pessimistic projections thanks to robust tax receipts. Yet, a closer look reveals a different story.

Purchasing managers' indices (PMIs), which serve as real-time indicators of economic activity, plummeted to their lowest level since January 2021 at the end of August this year. Sales figures remained lacklustre, and unemployment, once dormant, has begun its ascent.

Euro's Ascent Against the Pound: A Symptom of Uncertainty

Adding to the prevailing economic uncertainty, the Euro has been making significant gains against the British Pound. The EURGBP pair has been moving in a strong uptrend since September 6 and is currently trying to break above the psychological resistance levels near 0.8670. These divergent trends have sowed confusion in the markets, leading to fluctuations in bond prices and interest rate predictions.

The Stagflation Conundrum

Economists point to stagflation as the root cause of this rollercoaster ride in economic news. Stagflation, characterised by high inflation coupled with stagnant economic growth, can cause unadjusted measures, such as wages, to surge rapidly. This trend is evident in the UK's wage landscape, where the three months leading to June witnessed the fastest wage growth on record.

With inflation showing signs of moderation, it still clocked in at an annual rate of 6.8% in July, far exceeding the Bank of England's 2% target. In cash terms, total wages have risen by a staggering 21% since February 2020. However, when adjusted for inflation, they remain virtually unchanged. This robust wage growth has likely contributed to the notable 5-point increase in UK consumer confidence observed in August.

The Telltale Signs of Stagflation

In a period characterised by stagflation, nominal indicators like wages and tax revenues typically rise at a faster pace than real indicators such as PMIs, real GDP, or GDP growth. This stark discrepancy is clearly mirrored in the UK's economic data, underscoring the complexity of the current economic climate.

As the nation grapples with the possibility of stagflation, it faces a delicate balancing act in navigating the economic waters. The resolution of this conundrum will depend on a myriad of factors, including inflation trends, wage dynamics, and the resilience of economic growth. Amidst this uncertainty, investors, policymakers, and market participants remain watchful, hoping for clarity on whether stagflation will persist or not.