UK could be headed for ‘stagflation’ as economy flatlines and inflation bites due to Trump’s Iran war
According to at least one bleak forecast, the UK is heading towards “stagflation” as energy prices fall and inflation rises as a result of the Iran war.
Stagflation, the combination of rising inflation, high unemployment, and low or no economic growth, is seen as a “worst of both worlds” scenario because it is difficult for policymakers to make clear choices.
If they increase employment it will only increase inflation. If they fight inflation it will hurt growth.
RSM UK chief economist Thomas Pugh said: “President Trump’s announcement of a naval blockade of the Strait of Hormuz has shifted attention back to high energy prices and recession risks. It now seems inevitable that the UK will enter a new stagflation crisis, even if inflation is not as high as in 2023.”
“Further restricting supply leaving the region is pushing energy prices to levels that will trigger demand destruction in Europe, the UK and Asia. This will send the UK into recession and potentially force the Bank of England to raise interest rates.”
Inflation reached 12.8 percent in 2023. According to official figures for March, it is currently at 3.3 percent.
The last time the Bank of England met to discuss interest rates it kept rates at 3.75 per cent. Before the war, the strong expectation was that interest rates could fall two or three times this year, reducing borrowing costs for homeowners and businesses.
Economists still say the Bank can continue on its original path as long as the conflict in Iran does not continue until the end of the summer. The bank thought inflation had fallen before the first attack.
Not all City economists are so pessimistic. No one thinks the economy is about to explode, but they suspect a recession is coming.
Paul Dales, UK chief economist at Capital Economics, said: “While we acknowledge the huge uncertainty, we think it is more likely that the UK economy will stagnate rather than contract significantly. And with the labor market currently much weaker than in 2021-22, this period of inflation is likely to be milder and shorter, perhaps rising from 3 per cent in February to a peak of up to 4 per cent at the start of the year. I doubt interest rates are already quite high.” The Bank of England will increase interest rates in response.”
But Mr Pugh said the UK would face stagflation even if the truce continued because of the damage to consumer confidence caused by high fuel and mortgage costs.
He added: “Energy prices at current levels are still sufficient to push inflation above 3 per cent by the end of the year. Add in higher transport and raw material costs and supply chain disruptions and it is easy to achieve inflation of around 3.5 per cent/4 per cent by the end of the year. This is well above the 2 per cent to 2.5 per cent we were expecting in February.”
Meanwhile, business bosses are also worried. HSBC CEO Georges Elhedery told Bloomberg: “We are saddened and concerned about what is happening in the Middle East, not only about what is happening but also how long it will last. Unfortunately, some of these uncertainties initially started to negatively impact overall confidence.”
