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Sense of unease pervades financial markets over potential for stagflation – amid higher prices and Covid resurgence

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Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown:

‘’The creeping UK headline inflation rate is likely add to the sense of unease pervading the financial markets about the impact higher prices will have on economies around the world, as concerns about new Covid variants also rise. The FTSE 100 opened lower amid expectations central bank mass stimulus programmes may start to be eased more quickly, even though the recovery remains fragile.

“Although, for the moment, central banks are largely keeping their cool, appearing confident the spectre of lingering inflation will disappear, there are increasing signs of nervousness among investors, especially as readings in other countries also show price spikes. Although much of the increases are related to the unusually low level of prices last year due to the pandemic effect, it appears genuine price inflation is also occurring.

“Also playing on minds are surging Covid infection rates due to the spread of the delta variant and how these could slow the economic recovery. This raises the unpalatable possibility that stagflation could take hold, where there is a drag on economic growth and knock on higher unemployment, amid the headache of rising prices.

“The Nasdaq and S&P 500 fell back from record highs yesterday as data showed prices in the US grew at their fastest pace in 13 years last month. The US producer prices index due out later today will be closely watched as it should give a fresh indication about whether pressures which have been mounting up due to increases in commodities and factory gate prices are being sustained.

“Attention will also be drawn to US Congress later today where Fed chair, Jerome Powell, will face questions about monetary policy, particularly given suggestions from other central bank officials that the mass bond buying programme may need to be scaled back sooner rather than later. He’s likely to hold the transitory line on inflation and maintain that the higher prices we have seen are mainly due to the effects being felt from the pandemic bounce back, and so won’t be sustained. Recent Federal Reserve minutes also showed some officials felt uncertainty surrounding the economic outlook was still elevated.

“Although there is recognition that financial markets and the wider economy needs to come off the drug of cheap money, there is concern about how smoothly the withdrawal is administered, with fears that any hint of a cold turkey shock could cause significant volatility for more risky assets in particular.’’

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