Stagflation is engulfing the UK economy, showing what could lie in store for the US and Europe

Stagflation is engulfing the UK economy, showing what could lie in store for the US and Europe
UK railway workers have gone out on strike over pay, jobs and working conditions.Aaron Chown - PA Images/Getty Images
  • Talk about stagflation is growing in the US, but it's the UK economy that's likely to stall soon.
  • Britain already faces the highest inflation rate in the G7 — and it's predicted to climb even higher.

Talk of "stagflation" — the dreaded combination of stagnant growth and rampant inflation — is growing louder in the US after the economy shrank for two quarters running.

Sure, inflation is red-hot, and the economy is dangerously close to a recession. Yet many still expect the next two years to deliver relatively strong growth, and that's after a rapid rebound from the coronavirus crisis.

Over the pond in the UK, however, things are different. Economists say Britain is barreling towards a period of stagflation, with growth expected to slow to a crawl next year.

UK inflation rocketed to a new 40-year high of 9.4% in June as fuel prices surged, official data showed. That's higher than in any of the other G7 countries — Canada, France, Germany, Italy, Japan, and the US. It's likely to top double figures before the year is out.

Soaring prices, rising interest rates, tax hikes, and Brexit are all hitting the UK economy at once. The country's gross domestic product will grow just 0.7% next year, for the worst performance in the G7, private-sector economists polled by Bloomberg predict.


The Bank of England is even more pessimistic. It thinks GDP is likely to shrink slightly in 2023, and grow just 0.25% the following year.

Meanwhile, economists expect the US economy — which fared much better during COVID — to expand 1.3% in 2023. And they think eurozone GDP will increase by the same amount.

The UK's leaders are under pressure

For policymakers in the US, and the better-performing European economies, Britain contains a warning of what could be coming if things go wrong.

Leaders in the UK are under growing pressure over the bleak outlook. Rail workers, lawyers and mailmen are striking as the cost of living spirals higher. Consumer confidence has plunged.

In fiery TV debates this month, Boris Johnson's potential successors as UK prime minister inadvertently trashed the government's economic record.


"All your bills, every month, they're going up and up and up," said Rishi Sunak, who led the UK's economy ministry over the last three years. The other candidate, Foreign Secretary Liz Truss, said the UK faces "the worst economic crisis in a generation."

Energy bills reach eye-watering levels

At the heart of the UK's woes is an inflation rate that is outstripping that in other rich countries, and is likely to keep rising this year.

The country's energy price cap, designed to ease the burden on utility bill payers, is now adding to the pain.

The cap jumped 54% in April, and is set to rise by a similar amount in October to reflect a surge in oil and gas prices driven by Russia's invasion of Ukraine.

"Energy prices go up and stay there for a more prolonged period of time, rather than come down with the market," Sanjay Raja, chief UK economist at Deutsche Bank, told Insider.


A sharp drop in the British pound has made things worse, Raja said. It's fallen around 11% this year against the dollar, as the Federal Reserve's rate hikes have sucked money back into the US. The UK imports much of its food and energy, and a weaker pound is making those purchases even more expensive.

The workforce has shrunk

On top of a European-style energy shock, the UK is suffering from a problem more familiar to the US: a shortage of workers. More than 400,000 people have dropped out of the workforce since the start of the pandemic, economists estimate, with around half because of long-term illnesses.

Companies are putting up wages as they compete for a smaller pool of workers, adding to the pressure on prices, according to Ruth Gregory, senior UK economist at consultancy Capital Economics.

"You've got these acute labor shortages, which have held activity back in some service sectors, stoking rises in pay growth and higher inflation," she told Insider.

Brexit has also cut the size of the UK workforce by making it harder for people to move to the country, Gregory said.


Brexit and tax rises aren't helping

Deutsche Bank's Raja said Brexit is also causing other problems.

"Firms are telling us [about] additional paperwork, logistic costs, and in some cases higher tariffs as a result of leaving the European single market," he said. "Those things have also driven up imported goods prices."

Tax rises, which came into force in April in an effort to cut the budget deficit, are also adding to the squeeze.

"As far as I know, we are the only advanced economy to have pushed through a tax rise this year in the midst of the cost of living crisis," Raja said.

It's the stuff of nightmares for the Bank of England, which is hiking interest rates hard and seems resigned to a sharp slowdown in growth. "Its path to achieving a soft landing is narrower than the Fed's," Gregory said.


But it's even worse for millions of Britons struggling to get by during the worst cost-of-living crisis in a generation.

In real terms, wages are falling sharply. More and more people are turning to food banks, and discontent among workers is growing. Whoever succeeds Boris Johnson faces a daunting task.