Stagflation: What it is and why we should all be concerned

Amid the flurry of analyst reaction to the latest cut in interest rates, one word stands out - stagflation.

It comes after the Bank of England warned that inflation was likely to rebound to 3.7 per cent this year, against the 2.5 per cent that it fell to at the tail end of 2024. The central bank’s forecasts also show the UK economy continuing to flirt with recession.

The bank halved its growth forecast for the UK economy to just 0.75 per cent for this year, down from previous estimates of 1.5 per cent, before accelerating again in 2026 and 2027. The downgrade is a major blow to Chancellor Rachel Reeves after Labour made growing the economy its key priority.

Inflation may have eased but shoppers will have noticed that many prices are still rising. The Bank of England has warned that inflation is likely to rebound to 3.7% this year.

Bank policymakers face a tricky balancing act in the months ahead amid concerns the UK could enter a period of stagflation - where there is sticky inflation and muted or no economic growth for a protracted time.

Laith Khalaf, head of investment analysis at financial platform AJ Bell, issued a “stagflation alert”, noting: “Rising prices will not make for happy consumers who might have hoped that high inflation is in the rear-view mirror.

“CPI at 3.7 per cent is nowhere near the double-digit inflation we saw at the height of the cost of living crisis, but it adds to the cumulative load of price rises. It also sets up the potential for a round of higher salary negotiations, and with wage growth already running hot, this might stoke further inflationary pressures.

“The bank can control these by keeping interest rates higher, which would mean more sustained pain for mortgage borrowers and for companies refinancing debt.”

Nigel Green, chief executive of global financial advisory heavyweight deVere Group, said: “The Bank of England has backed itself into a corner where it is too scared to cut rates aggressively due to lingering inflation, yet it also sees clear evidence that the economy is grinding to a halt. By trying to do both, it achieves neither - ensuring stagflation takes hold for a prolonged period.

“This was the moment to act decisively, to drive growth and give businesses and households the breathing room they desperately need. Instead, the [bank’s] monetary policy committee has delivered a lukewarm response that could prolong economic pain. The UK is heading straight into stagflation, where growth stagnates but inflation remains stubbornly high.”

Susannah Streeter, head of money and markets at investment platform Hargreaves Lansdown, added: “The risks of stagflation are stark. Inflation remains above the Bank of England’s 2 per cent target and price pressures are piling up, but the economy is stagnating, and business confidence has taken a knock.

“The bank has slashed its forecast for growth this year, which keeps the door wide open for multiple rate cuts to come. Other data out this week shows that job cuts are landing at the steepest pace in four years in the services sector and the activity in the construction sector contracted unexpectedly in January for the first time in a year.”

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