Chancellor Rachel Reeves faced a further setback this week when growth forecasts for the coming year were cut in half, from 1.5% to 0.75%.
Although the forecast was cut for this year, the Bank of England upgraded its predictions for 2026 and 2027, when it said the economy would grow by 1.5% both years, up from a previous forecast of 1.25%.
However, many observers blamed this year’s gloomier forecast on the government’s October budget and its impact on business and hiring confidence, and warned that the combination of potentially higher inflation in the future, together with low growth, could lead to “stagflation”.
Stagflation is a combination of three negative forces: slow economic growth, higher-than-normal unemployment, and a higher cost of living. It was a feature of the UK economy in the 1970s, when there was high unemployment due to declining British industry and inflation rates that topped 20%.
UK labour market
The BoE cut interest rates yesterday from 4.75% to 4.5%, warning that any further falls in the rate would be “gradual and careful” because of a predicted rise in inflation when rates are cut.
The current rate of inflation measured by the consumer prices index is 2.5%, and the BoE predicts it could rise to 3.7% by the third quarter of this year.
That growth will in part be fuelled by rising wages, including a 5.5% increase in pay for public sector workers, and a 6.7% rise in the national living wage.
There could also be a knock-on effect from the introduction of tariffs on imports to the US by President Donald Trump.
In the short-term, the interest rate cut will mean many workers can stretch their wages further as mortgage payments will drop slightly, but the longer-term risk of stagflation on hiring and employment confidence could be more dangerous.
Some also hint at the risk of the UK economy heading into recession, which will impact firms’ ability to hire and offer pay rises.
Nicholas Hyett, investment manager at Wealth Club, said: “Recent economic data points to a slowdown in the UK economy – GDP came in lower than expected, inflation has fallen and unemployment has ticked up.
“The outlook is gloomy too, with many companies thought to be considering job cuts before a rise in the living wage and higher national insurance contributions in April.”
Responding to its flash UK composite purchasing managers’ index last week, Chris Williamson, chief business economist at S&P Global Market Intelligence, said: “The first indicators of business conditions in 2025 add to the gloom about the UK economy, with companies cutting employment amid falling sales and concerns about business prospects.
“Inflation pressures have meanwhile reignited, pointing to a stagflationary environment which poses a growing policy quandary for the Bank of England.
“While output growth ticked higher, the improvement does little to move the dial on a speedometer which points to an economy that is broadly flatlining.”
Further rate cuts needed
Other commentators argue that the BoE is moving too slowly on cutting interest rates. Indeed, two of the nine-member Monetary Policy Committee advocated an interest rate cut to 4.25%.
Carsten Jung, principal research fellow and head of macroeconomics at think tank the Institute for Public Policy Research, said: “The recent economic weakness in the UK is primarily driven by too high interest rates.
“While many commentators focus on project-by-project discussions that individually have small effects, the elephant in the room is high rates. [Thursday’s] rate cut was therefore much needed, but the Bank is still moving too slowly.
“We are in the last mile of returning to normal rates of inflation. While the energy price shock is still rippling through the system, recent measures of underlying inflation show we are back to historical averages. By keeping rates high the Bank has been perhaps understandably cautious, but their current stance looks increasingly zealous.”
Paul Nowak, the general secretary of the TUC, agreed that further rate cuts are needed to support households and businesses. “This rate cut is badly needed to help lift the economy out of stagnation. The Bank must now keep moving with further cuts,” he said.
Sharon Graham, general secretary of the Unite union, is urging the government to continue with its infrastructure and investment plans to jolt the economy into growth.
Last week the government announced a number of ambitious growth projects, including building a third runway at Heathrow, which it said could create around 100,000 jobs.
Graham said: “No investment equals no growth. So what are we waiting for? There are plenty of projects crying out for public investment that will drive growth and create good jobs.”
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