Is Britain on the brink of stagflation?

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The Bank of England’s interest rate cut today will have come as welcome, albeit expected, news for Rachel Reeves. Less welcome news for Britain’s beleaguered Chancellor is its accompanying growth forecast.

The BoE’s Monetary Policy Committee voted to cut interest rates from 4.75% to 4.5% - bringing them down to the lowest base rate since June 2023. Though the clear consensus to cut rates - with two of nine members even voting for a bumper half percentage point cut - also points to the increased pessimism surrounding the UK’s weak economy.

Today, Britain’s central bank downgraded its forecast for growth this year from 1.5 per cent to 0.75 per cent, adding that economic growth has been “broadly flat since March last year”.

In a blow to Reeves, the Bank raised concern over declining business and consumer confidence - and the firms who have “mentioned the Budget as a deterrent to investment”.

Today’s rate cut will make borrowing that bit cheaper, reduce the cost of business and home loans and encourage spending.

Though a big boost to business confidence will take more than one quarter-point cut, meaning Reeves will be desperately hoping this is the first in a series of cuts.

On this front, Governor Andrew Bailey offered no guarantee, choosing his words cautiously. Amid so much domestic and global uncertainty, the Bank will take a “careful and gradual” approach to future interest rate cuts as it weighs up a number of factors that could affect inflation, said Bailey.

Worryingly, inflation is set to rise again this year, by more than previously expected, peaking at 3.7 per cent and remaining above the Bank’s target of 2 per cent into 2027.

Last year, the Bank was forecasting slow growth but falling inflation. This new stagflationary prospect - of even slower growth paired with rising inflation - is a dismal one.

That inflation is on the rise again is largely down to global factors outside of the government’s control. While UK-specific issues such as higher water bills and bus fares have played a small part, by far the main driver is energy prices, which are up about 20 per cent on what had been anticipated several months ago, thanks to a chilly winter across Europe which has drained gas storage levels.

Another glaring global factor fuelling economic uncertainty is Donald Trump’s tariff threats. And it will certainly be another reason why Bailey is reluctant to commit to further rate cuts.

Even tariffs not directly imposed on Britain would hit the UK economy. Though when it comes to exactly how tariffs might affect UK inflation, it’s not a straight forward picture. They could create somewhat conflicting pressures.

On the one hand, tariffs could be inflationary. Economists widely believe that any tariffs Trump imposes on other countries will raise US costs, sparking a wave of inflation there that would force the Fed to keep interest rates higher for longer. If US interest rates stay high, that would be bad for the pound and in turn make Britain’s imported goods more expensive.

Conversely, if Trump’s tariffs unleash a world trade war that significantly reduces the amount of supply chains Britain has built up around the world, that would be bad news for both the supply and demand side of the economy. And could lead to deflation.

So, do we think more rate cuts are on the way? Quite possibly, but for now, fears that Britain is on the brink of stagflation means the Bank of England is walking a difficult tightrope.

Caitlin Allen

Deputy Editor

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