What is Stagflation and How Could it Impact UK SMEs?

Stagflation is a term that has been mentioned much more frequently in the media in recent months, in our post-pandemic world, as high inflation particularly has been hitting the UK hard.

Read all about stagflation in this latest Q&A with our Managing Director, Andrew Raphaely.

A: Stagflation is characterised by stagnant economic growth, high unemployment, and high inflation. Economic policymakers find this combination difficult to resolve because attempting to correct one of the factors can exacerbate another. The Office for National Statistics (ONS) reported last month that the economy has ‘shown no growth’ in three months.

Whilst recent inflation data indicates the economy is responding to monetary tightening, it remains well above the 2.0% target. Further, labour shortages and other global supply-side inflation factors remain in play and can be more resistant to rate rises. Therefore, there is concern that a period of stagflation may materialise. Even in the event that stagflation is avoided, the significant time lag on the impact of monetary policy actions promotes uncertainty which is not a favourable environment for growth nor investment.

A: Inflation is currently at 7.9% compared to 8.7% a month ago and there is hope it will continue to ease over the next several months back towards the 2.0% target. There is a level of optimism given this decline albeit there is a long way to go amid continued uncertainty from the supply side shocks of Brexit, Covid and the conflict in Ukraine.

As of June, the Confederation of British Industry (CBI) upgraded its economic forecast and now expects that the UK will avoid a recession with the economy expected to grow by 0.4% in 2023, firming to 1.8% in 2024. Should those forecasts materialise and the economy avoid the ‘hard landing’ that many had feared, the UK economy should be in a stronger position to avoid stagflation than previously anticipated.

A: Inflation creates higher input costs that many SMEs find difficult to pass onto their customers. As we’ve seen, inflation is typically managed down with higher interest rates, which alongside higher input costs creates significant margin pressures that reduce profitability, cash flows and the scope for investment and new employment opportunities. This has far-reaching implications for economic growth, innovation and international competitiveness across many industries that support SMEs.

Our main concern, however, is that this combination of downside factors could jeopardise the survival of SMEs that are unable to source new and efficient forms of capital.

A: It is often the case that alternative lenders can serve the SME segment more efficiently as banks are often precluded from the sector due to unattractive risk-adjusted returns. These sub-optimal returns for banks arise from the higher regulatory capital requirements that are demanded against SME assets, relative to other investments such as gilts and mortgages.

In the event the economy enters a period of stagflation, there will be even less incentive for banks to lend into the riskier SME segment and therefore alternative finance will be one of the few avenues for SMEs to obtain necessary liquidity.

Alternative finance also provides SMEs with an increased array of different lending products. This increases flexibility in repayment profiles which is often attractive during challenging economic periods.

A: 365 finance is well capitalised with access to institutional debt funding. Notably, we recently increased our debt facility with Pollen Street Capital leaving ample headroom to expand our support to UK SMEs. As a result of our innovative product design, our customers will not be under pressure to make payments if their business slows down because repayments are linked to their turnover.

Given this inherent flexibility that provides maximum value during challenging and volatile periods, we are prepared for a meaningful rise in demand for our product.

A: The uncertainty caused by potential stagflation calls for contingency and scenario planning today. Running a comprehensive scenario analysis may not be feasible for SMEs with limited time and resources, but at a minimum there needs to be a focus on building a liquidity buffer that can support cash flows in the short to medium term.

The difficult rate environment we’re seeing today means there is a stronger case for paying a premium for fixed rate debt products, or those with in-built flexibility, to minimise the potential for cash flow shocks or liquidity crises. Ideally, the repayment profile demanded by financing is clear, foreseeable and matches an SME’s seasonal cash flows as closely as possible.

A: We would not foresee any need to adapt policies or terms. It is core to our mission that our product is suitable in all economic environments, even more so during challenging economic conditions.

A notable case in point was during Covid when our customers weren’t burdened with fixed debt repayments or spiralling interest costs during a period of little or zero revenues. The repayment amount on our product is fixed and the timing of repayments is entirely correlated with a merchant’s revenues. This serves as a significant cash flow support for SMEs in the event of a sustained period of stagflation.