Understanding Stagflation in the UK
Following the period of high inflation after Covid-19, the fear of stagflation in the UK's economy kept on rising. A combination of very high inflation faced the UK while economic growth stagnated and unemployment kept rising, or what is referred to as stagflation. Stagflation can severely affect a country and its living standards. This guide provides an in-depth analysis of stagflation.
Table of Contents
Economic Indicators and Their Relevance to Stagflation
Stagflation represents a time in the economy which has persistently high inflation, with high unemployment and stagnant demand for goods and services within the economy. The term was popularised by the British politician Iain Macleod in the 1960s.
The combination of slow economic growth, high inflation and high unemployment has significant ramifications for the economy. Below are a few important indicators relevant to stagflation.
Inflation (CPI)
Inflation figures are one of the most important economic indicators regarding stagflation. Inflation measures the change in the price of goods and services purchased by consumers and is a metric used by central banks to determine interest rate policy.
In the UK, inflation is measured using the Consumer Price Index (CPI). This figure is released by the Office for National Statistics (ONS) and measures the average price of various goods and services over a period of time and is then compared to the sampling from the previous month or year.
During a time of stagflation inflation stays persistently high, even when central banks and governments enact different policies to bring it lower.
Current Inflation Rate UK
The UK's inflation rate is measured using the Consumer Price Index (CPI). The CPI is a measure of the average price level changes for a basket of consumer goods and services. The basket of goods includes goods and services such as food, energy prices and cars. The CPI in December 2024 was estimated to be 2.5%. In February 2025, UK CPI rose to 3.0%, according to the ONS.
UK's Target Inflation Rate
The Bank of England tries to aim for an annual inflation rate of 2%. This is a globally accepted inflation rate and is considered a level which balances stability and growth for an economy. If the rate is much higher or lower, it usually means that the UK economy is facing severe challenges.
Historical Data on Inflation Rates
The 1970s represented the period of the oil crisis when CPI reached its peak. The recession in the early 90s also caused a surge in the CPI rate. An example of the deviation from the 2% inflation level is the COVID-19 crisis. After the outbreak of the virus, inflation rates heavily increased, due to a combination of lower supply and increased demand driving prices higher. Other factors, such as the Ukraine war, caused energy prices to rise and the blocked Suez Canal, causing hold-ups for global trade.
GDP Growth Rate
GDP stands for gross domestic product. It measures the total value of all the goods and services produced in an economy over a specific period of time. Effectively, it represents a country's level of income. In the UK, GDP figures are released by the Office for National Statistics (ONS).
During a period of stagflation, GDP figures tend to be lower or remain flat as there is not much demand for goods and services within the economy, causing stagnation.
Current GDP Growth Rate
In the first half of 2024, UK GDP grew strongly as it rebounded from the brief recession in 2023. However, since then, GDP has been falling with zero growth between July and September.
Due to changes in government policy, the Bank of England halved its growth forecast for 2025 as it remains concerned about the impact of high inflation. The chart underneath depicts what the quarter-on-quarter growth rates for the UK GDP have been since the 1960s. After relatively stable growth in the ‘80s and '90s, there was a drop in GDP around 2008, just when the financial crisis broke out. Also, Covid-19 had a huge impact on the economic growth of the UK economy.
Sectoral Breakdown of GDP Growth
According to data from the House of Commons, the services sector is by far the largest sector in the UK in terms of GDP. Besides the service sector, which accounts for around four-fifths of the economy, the manufacturing and construction sectors have a big influence.
The services sector includes professional services, business administration, finance, hospitality and retail. In 2022, it contributed £1.9 trillion to the UK economy. As such, half of UK exports come from the services sector, which is twice the OECD average (Organisation for Economic Co-operation and Development).
Unemployment Rate
The level of employment in an economy is important to its overall GDP growth and level of inflation. During a period of stagflation, unemployment is typically high as the lower demand for goods and services prevents businesses from hiring.
There could be other factors as well. For example, in the UK, the level of unemployed people due to long-term sickness is at its highest since the 1990s.
Current Unemployment Rate
Unemployment rates in the UK were estimated at 4.3% in the second half of 2024. Unemployment has been trending upwards from October 2023 to October 2024, increasing by about 0.5%. The rate of citizens who do not have work in the UK is at the lowest point since 1970. The high number of unemployed people in the UK was one of the causes of the recession in the 1980s.
Types of Unemployment in the UK
There are multiple types of unemployment in the UK.
- Cyclical unemployment is the result of economic cycles, including economic prosperity and downturn.
- Structural unemployment comes from permanent changes in an industry.
- Frictional unemployment is defined as a short-term period without work caused by a change of jobs.
As well as the different types of unemployment, the figures can vary depending on the region. KPMG forecasts that the unemployment rate will remain at 4.3% in 2025 and drop to 4.2% the year after.
Government Policies and Their Impact on Stagflation
Below are a few ways that government policy can impact stagflation.
Fiscal Policy
Fiscal policy refers to the way governments use spending and taxation to influence the economy.
Government Spending and Its Impact on Stagflation
Government spending can be used to try and boost economic activity in a country. In times of economic stagnation, it can help firms and households. However, an increase in government spending can drive up prices due to the increasing demand for goods and services that it causes. In turn, this can drive up inflation which affects stagflation.
Taxation Policies and Their Effects on Inflation
Taxation policies have the power to affect the disposable income of households and the profitability of businesses operating in the economy. This means that taxation can indirectly control the supply and demand of goods and services in an economy and overall inflation.
Budget Deficit/Surplus and National Debt
In early 2025, the national debt of the UK was around 100% of the current GDP. A high debt level can limit the ability of a government to implement different fiscal policies that help economic activity. This is because the debt level can affect how investors view the UK economy, influencing the demand for UK bonds and how much the government can borrow to help the economy.
Impact of Fiscal Policy on Inflation Rates
Expansive fiscal policies like increased spending and cutting taxes aim to increase demand, which can sometimes lead to rising prices. Contractionary policies result in reduced inflation but also the risk of economic stagnation.
Monetary Policy
Monetary policy refers to the actions from governments or central banks that control the supply of money and interest rates. In turn, this can affect inflation, GDP and unemployment levels which all influence the possibility of stagflation.
Interest Rates (Bank of England Base Rate)
Interest rates are set by the Bank of England and are used to try and control inflation. In order to try and lower prices in the economy and bring inflation down, central banks tend to increase interest rates. The hope is that higher borrowing costs may act as a downward pressure on demand. This is because high interest rates mean borrowing money is expensive and holding it in the bank is more interesting to savers.
Conversely, if an economy is stagnating, central banks will lower interest rates. The hope is that as borrowing costs come down consumers will spend more in the economy and businesses will invest in growth projects, thereby stimulating economic activity.
Quantitative Easing and Its Role in Managing Stagflation
After the COVID-19 crisis, economic activity fell. To boost the activity and economy, quantitative easing (QE) was brought in as a solution by central banks. Through quantitative easing, the central bank buys long-term government bonds to try and stimulate the economy. However, QE can result in inflation and stagflation because of the overload of money that is pumped into the economy.
Historical Events and Their Relevance to Stagflation
There have been many times in the past where certain events caused a period of stagflation. A few of these times are discussed below.
1970s Stagflation
The stagflation in the 1970s was caused by several events, mainly relating to an oil crisis, union power and strikes. The OPEC (Organization of the Petroleum Exporting Countries) oil embargo of 1973 caused oil prices to skyrocket. This made it difficult for the UK to import oil, as well as a much higher cost of goods and transportation.
During this time, British trade unions held considerable power as they negotiated larger wage increases to combat rising inflation. The miners' strikes in 1972 and 1974 disrupted the economy, influencing overall GDP. Overall, prices were soaring while the economy was not growing, and unemployment was stubbornly high, creating a period of stagflation.
The UK government tried to solve the crisis by increasing government spending and lowering interest rates. However, this led to higher inflation overall, exacerbating the issue. As such, the 1970s saw economists reevaluate their economic theories.
2008 Stagflation
In 2008, the UK experienced its worst recession since World War II. The global financial crisis caused by the subprime mortgage crisis in the UK banking sector led to the economy shrinking by 6% in the first quarter of 2008, the highest employment level since 1995 and a huge productivity slump. However, this period of time was not classed as a time of full-blown stagflation as inflation was not consistently high enough.
2025 Stagflation
In 2025, there are early warning signs of stagflation in the UK economy. For example, inflation rose to 3% in February 2025, which is much higher than the Bank of England's 2% target. The government hoped its policies would drive inflation down, but it had the opposite effect.
The Bank of England also halved its growth forecasts for the UK, highlighting the economy is likely to stagnate due to possible trade tariffs from the US and a higher tax burden on businesses from the rise in employers' national insurance.
However, as the unemployment level has been relatively low and stable in the UK, the economy has not entered stagflation but the risks are still high.
Conclusion
Stagflation is defined as a period of economic downturn where inflation is high, growth has stagnated, and unemployment is rising. It can cause serious economic challenges that can impact businesses and households. Tracking the three causes of stagflation can help investors to understand the future prospects of the economy and help make more informed investment decisions.
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