‘Stagflation’ is a term that makes regular rounds on the news and can be a point of real concern for the markets.
It refers to an economic condition when inflation is rising, but gross domestic product (GDP) and employment levels are flat or shrinking. This means that while goods and services are getting increasingly more expensive, the country is not seeing an influx of cash to keep pace. The effect trickles down to individuals, who face rising household costs on top of a tight job market.
Inflation rising without GDP growing may seem like a counterintuitive phenomenon, and historically many economists would have agreed. In fact, many thought it was impossible for inflation to rise and GDP to shrink at the same time, until it happened in the 1970s. But since then, it has been a major point of caution for governments and markets.
Recently, worries about stagflation have swirled around the news because the war in Iran has created concerns about renewed inflationary pressures. Since the war began, market bets on the Bank of England cutting interest rates in 2026 have all but disappeared because of concerns that rising oil prices will lead to broader inflation.
What’s the UK’s inflation situation?
Before the war in Iran, inflation in the UK was on a slow descent. The most recent consumer price inflation reading was 3%, but the Office for Budget responsibility anticipated a sink to 2.3% for 2026 as a whole at the beginning of March. Now, analysts believe that if conflict continues, this figure could be between 3% and 4%, according to Reuters.
These must be taken with a grain of salt, particularly because we don’t know how long the war in Iran will continue.
On the economic growth side, worries in the UK began before the war in Iran. In the month of January, the Office for National Statistics (ONS) showed no growth in GDP, and just a 0.2% increase for November 2025 to January 2026. The Office for Budget responsibility forecast GDP growth of 1.1% for 2026 before the conflict began.
What are the signs of stagflation, and solutions?
Economists and markets are on alert for signs of stagflation, but it can be hard to pinpoint. Inflation rates bounce around with factors like energy prices causing temporary effects, making long-term patterns harder to predict. GDP has similarly been a point of worry for the UK. According to the ONS, GDP grew by 1.1% in 2024, and 1.3% in 2025, meaning growth of 1.1% this year would represent a slowing of what modest momentum the economy had.
The real problem with stagflation comes with trying to fix it, because inflation and GDP are often used as levers against each other in the sense that growth-limiting interest rate hikes are used to tame rising prices. But in a stagflationary environment, central banks and governments might have to turn to other measures.
One potential solution is an increase in productivity, which would boost GDP. But practically speaking, this is a tall order in a limited amount of time. Another option is taking more extreme measures with interest rates. This was the approach taken in the 1970s, when the phrase stagflation was first coined.
What can we learn from when stagflation happened before?
When stagflation first occurred in the 1970s, there was no single cause. Governments in the UK and in the US were following Keynesian financial models, which meant that government intervention was used to keep economic growth on track.
But the decade saw a spike in oil prices that coincided with dispute among industrial workers, leading to strikes and unemployment. The issues caused the rate of return on capital to dip below the interest rate set by the Bank of England by 1975. While businesses were previously supported by government stimulus (similar to that seen during the COVID-19 pandemic), this began to run dry, and businesses instead laid off workers and increased prices to make up for profits.
This combination of tactics by businesses provided a perfect environment for stagflation, as inflation increased as people were charged more, and fewer workers meant less growth.
To end this cycle in the UK, the government raised interest rates to a peak of 17% in 1979, and widely cut back government spending. While this did eventually lead to a calming of inflation and GDP began to pick back up as labour contracts were established, it did cause pain for the public. Stagflation helped push unemployment from 3.5% in 1973 to 11.9% to 1984.
How worried should I be?
The effects of stagflation can be concerning, and it’s a difficult position to recover from. But it’s important to recognise that the direction the economy is heading is never set in stone. There’s a large variety of known factors that could cause changes in inflation levels in the next few years, and there’s another bundle of unknowns. Currently, an interest rate rise to 17% (or anywhere close to this rate) does not seem to be on the docket. Instead, rates are largely expected to stay put or see minor, incremental increases, instead of the decreases that were previously pencilled in for the year.
The most helpful way to protect yourself from the effects of stagflation is to ensure that your investments are in a comfortable position for your future plans and are well diversified to weather different market conditions.
Hannah Williford: Content Writer
Hannah joined AJ Bell in 2025 as an investment writer. She was previously a journalist at Portfolio Adviser Magazine, reporting on multi-asset, fixed income and equity funds, as well as macroeconomic impacts and regulatory changes...
