Morgan Stanley economists still see stagflation — weak growth and elevated inflation — dogging the global economy for the next several quarters.

“We look for a prolonged period of relative economic stagnation in the G-7 countries rather than a deep recession, and we think that persistent underlying inflation pressures will limit the oil price-induced decline in headline inflation rates that lies ahead,” it says in a research note. “Thus, stagflation is still the name of the game, in our view, limiting the major central banks’ room for manoeuvre on interest rates in both directions”.

“Even though we don’t foresee a sharp recession, our G-7 economic outlook is far from rosy,” it says. “Over the next several quarters, we see virtually no growth overall, with a technical recession still likely in the U.S. during the winter, and Europe (including the UK) and Japan bumping along the zero line. Moreover, while moderate recoveries look likely at some stage during 2009, we expect them to be very hesitant and sub-par.”

The recovery will likely be weak, Morgan Stanley notes, because

> there is little room for monetary easing;

> credit conditions will remain tight for the foreseeable future;

> house prices are falling; and,

> a forecast downshift in potential output growth in many industrialized economies, due to the energy price shock, the credit crisis, and emerging trends towards re-regulation and protectionism.

Yet inflation will also remain an issue, it argues, suggesting that underlying inflation pressures will remain elevated and inflation rates will hover in a higher range over the next several years than we got used to in the last 15 years or so.

“Rather than a deep recession, we continue to expect a prolonged period of relative economic stagnation in the industrialized world — or as in the U.S., mild technical recessions. No deep recession, no vigorous recovery. With potential growth downshifting, too, and global monetary policy very easy, underlying inflation pressures should remain elevated, despite the coming decline in headline inflation,” it concludes. “The uncomfortable mix of no growth but lingering inflation pressures severely limits central banks’ room for manoeuvre on interest rates. Specifically, we continue to think that market expectations of major rate cuts in the euro area and in the UK will be disappointed.”