UK could be headed for ‘stagflation’ as economy flatlines and inflation bites amid Trump’s Iran war

Britain is heading for “stagflation”, according to at least one gloomy forecast, as energy prices bite and inflation jumps as a result of the Iran war.

Stagflation – a combination of rising inflation, higher unemployment and low or zero economic growth – is seen as a “worst of both worlds” scenario because it is hard for policymakers to make clear choices.

If they boost employment, that only adds to inflation. If they fight inflation, that hurts growth.

Thomas Pugh, chief economist at RSM UK, said: “President Trump’s announcement of a naval blockade of the Strait of Hormuz has shifted the focus back to the risks of higher energy prices and recession. It’s now looking inevitable that the UK is in for another bout of stagflation, even if inflation won’t go as high as in 2023.

“Further constraining supply leaving the region pushes energy prices to levels that would trigger demand destruction in Europe, the UK and Asia. That would tip the UK into recession and potentially force the Bank of England to raise interest rates.”

Inflation hit 12.8 per cent in 2023. It is now at 3.3 per cent, according to official March figures.

Last time it met to discuss rates, the Bank of England held them at 3.75 per cent. Before the war, the strong expectation was that rates could come down two or three times this year, cutting borrowing costs for homeowners and businesses.

Economists still say the Bank can resume its original path as long as the Iran conflict doesn’t drag out past the summer. Inflation, the Bank thought, was coming down prior to the first attack.

Not all City economists are so pessimistic. None think the economy is about to boom but they doubt a recession looms.

Paul Dales, chief UK economist at Capital Economics, said: “While acknowledging the huge uncertainty, we think it is more likely that the UK economy will stagnate rather than contract significantly. And because the labour market is much weaker now than in 2021/22, this bout of inflation will probably be milder and shorter, perhaps with inflation rising from 3.0 per cent in February to a peak of 4.0 per cent around the turn of the year. And with interest rates already reasonably high, I doubt the Bank of England will raise interest rates in response.”

Mr Pugh says the UK will suffer stagflation even if the ceasefire is resumed because of the damage done to consumer confidence by higher fuel and mortgage costs.

He added: “Energy prices at current levels are still enough to push inflation above 3 per cent by the end of the year. Once we add in higher shipping and raw material costs and supply chains disruptions, it’s easy to get to inflation of around 3.5 per cent – 4.0 per cent by the end of the year. That’s significantly higher than the 2.0 per cent to 2.5 per cent we were expecting back in February.”

Meanwhile, business bosses are also concerned. HSBC CEO Georges Elhedery told Bloomberg: “We’re saddened and concerned with what’s happening in the Middle East, and we’re concerned not just with what’s happened, but also with how long this will take. Unfortunately, some of these uncertainties have initially started to weigh on general confidence.”