Stagflation: Chancellor Rachel Reeves faces mess of her own making
Chancellor Rachel Reeves suffered a major blow after the Bank of England slashed its growth forecasts for this year while also predicting a surge in inflation.
The Bank now expects the UK economy to grow 0.7 per cent this year, cut from a previous estimate of 1.5 per cent. Inflation, meanwhile, will hit 3.7 per cent later this year.
Speaking on the BBC’s World at One, Jonathan Haskel, professor of economics at Imperial and a former rate-setter, said the forecasts could be “summarised in one word…which is stagflation.”
Stagflation refers to the challenging combination of high inflation and weak growth.
Andrew Bailey, Governor of the Bank, rejected the term. “I don’t use the word stagflation. It really doesn’t have a particularly, frankly, precise meaning,” he said.
“In terms of pushing back on stagflation, I really would come back to that point that our judgement today is really anchored on a view that we think the disinflation trend is in place,” he said.
But despite Bailey’s protestations, many economists in the City felt stagflation was an appropriate description.
“All in all, with inflation up and growth down, stagflation risks remain on the table,” Anna Leach, chief economist of the Institute of Directors, said.
Rachel Reeves faces pain as Office for Budget Responsibility set to cut growth forecasts
Many economists expect the Office for Budget Responsibility (OBR) to follow the Bank’s example and cut its own growth forecasts next month.
This would likely force Rachel Reeves to either raise taxes again or cut spending in order to meet her fiscal rules.
The Bank’s forecasts suggest that growth was particularly slow in the wake of Labour’s maiden Budget, with GDP likely to have contracted in the final three months of 2024.
Bailey pointed to the deterioration in business and consumer confidence, which suggests a “slowdown in demand” as a key reason for the sluggish performance.
“Weakness has been more pronounced in the market sector, in which output has recorded little growth over the past year while activity in predominantly public sectors has been rising strongly,” the Bank’s latest forecast noted.
Firms are also facing pressure from the looming national insurance hike, the flagship policy of Rachel Reeves’s initial budget, which will force them to hike prices, shed staff or cut wages unless they want to absorb the extra costs in their margins.
Businesses will likely choose some combination of all options, but the Bank noted that lower-paid workers would be the most likely to lose their jobs.
That’s because the simultaneous rise in the minimum wage made it more difficult for firms in those sectors to cut wages. Unemployment is expected to reach 4.8 per cent in 2027.
Compared to November, the Bank also expected the tax hike to have a “marginally larger impact on prices” in the short term.