Stagflation on the Horizon: Britain Faces Economic Challenges

The return of inflation and the simultaneous shrinking of the economy awaken the dreaded prospect of 'stagflation' in the United Kingdom, a portmanteau describing the unfavorable combination of economic stagnation and persistently rising prices. According to Suren Thiru from the Institute of Chartered Accountants in England and Wales (ICAEW), this is the 'worst of both worlds', where high interest rates to combat inflation further burden the economy. The Consumer Price Index (CPI) recorded an increase to 2.6 percent in November, after being at 2.3 percent in October, according to the Office for National Statistics (ONS). Although this is only slightly above the Bank of England's target of 2 percent, inflation is expected to rise further in the coming months. The extensive tax increases announced by Finance Minister Rachel Reeves are causing price hikes for businesses. Rob Wood, Chief UK Economist at Pantheon Macroeconomics, predicts that CPI inflation could reach 3.1 percent in April. Simultaneously, there is a slump in economic growth, with the Gross Domestic Product (GDP) declining by 0.1 percent for two consecutive months. The combination of rising inflation and shrinking economic growth poses the risk of the UK falling into the stagflation trap, explains Andrew Wishart, Senior UK Economist at Berenberg. The UK experienced an extreme phase of stagflation in the 1970s, when the economy contracted and inflation soared. Thiru sees parallels to the current situation, even if it is not quite as extreme as it was then. The recent energy shock and the high budget deficit are reminiscent of that crisis. Handling stagnation proves particularly difficult, especially as the usual inflation-fighting measure of raising interest rates has little effect during a stagflationary phase.