GDP Report Could Spur Talk of Stagflation

Stagflation is a word that might spring to mind on Friday morning after the second-quarter gross domestic product report is released.

Because economic growth is expected to rise a healthy 3.7% in the quarter and the GDP price deflator is projected to increase at a 3% annual pace, talk of stagflation -- a stagnating economy with spiraling inflation -- probably sounds like hyperbole and for the most part, it is. But it's easy to see why the term has crept back into investors' lexicon.

In recent weeks, real economic growth estimates for the second quarter by Wall Street economists have been revised down by 40 basis points, according to Banc of America analyst Tom McManus. At the same time, forecasts for inflation have risen by roughly the same amount, leaving the nominal rate of growth unchanged. (Real GDP is adjusted for price fluctuations while nominal growth is not.)

A similar trend has emerged over the past two quarters, with the rate of real GDP growth slowing as inflation has moved higher. In the first quarter, GDP rose 3.9%, compared with a 4.1% increase in the fourth quarter and 8.2% gain in the third.

Meanwhile, the GDP deflator rose at a 2.9% pace in the first three months of the year, up from a 1.5% pace in the prior quarter. The personal consumption expenditure index, a measure of inflation preferred by the Federal Reserve, also has jumped sharply.

"If you average the first two quarters of this year, I think growth will end up being a little bit weaker than was expected going into the year and inflation is definitely higher," said Josh Feinman, chief economist at Deutsche Asset Management. "It's been a while since we've had that combination."

Still, Feinman said it's premature to suggest that this recent trend will lead to actual stagflation. And McManus agrees, saying he wouldn't be worried unless the rate of real growth fell below the rate of inflation.