What is stagflation and what can be done about it?

The final months of 2024 saw the UK enter an economic state that many economists might define as stagflation.

Inflation, which had trended downwards through the year, was back on the rise. Annual inflation, as measured by the Consumer Prices Index (CPI), increased in October and November, to 2.3% and 2.6% respectively. While the annual rate of price increases saw a surprise drop in December, to 2.5%, it remained above the Bank of England’s 2% target.

Meanwhile, economic growth was almost non-existent. UK GDP increased by just 0.1% in November, and even that figure was an improvement on what had come before: the economy had contracted by 0.1% in both the preceding months.

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This combination of stagnant or negative growth with inflation is referred to as stagflation (a portmanteau of ‘stagnation’ and ‘inflation’).

“While many were away on Christmas break, the ONS quietly revised down its estimate of Q3-24 GDP growth from 0.1% Q-o-Q to 0% Q-o-Q, raising the spectre of stagflation in H2-24,” said Sanjay Raja, chief UK economist at Deutsche Bank.

How does stagflation occur?

“Stagflation arises when there are rising prices in an economy, but no growth or stagnation,” Jane Sydenham, investment director at Rathbones Investment Management explained.

“In the UK, where the economy is growing slowly, services wage inflation has been persistently stronger than the average, as there have been skills shortages.

“Wage inflation in hospitality where many employees are lowly paid has been quite strong, and the increase in the minimum and living wage has added to that.”

Stagflation can have dire economic consequences, in no small part because it confounds the usual fiscal logic. Prices shouldn’t go up when we have less money to spend.

“Generally, inflation is accompanied by growth, as salaries and prices usually rise in response to growing demand,” said Sydenham, adding that stagnation is “damaging, because costs rise, but there is no growth to compensate for rising costs, and so the economy becomes less productive”.

What can central banks, policymakers and government do about stagflation?

Stagflation is a tricky problem for governments and economists to solve. Inflation usually results from too much economic activity, while stagnation usually results from too little.

The policy levers that governments and central banks use to combat them are therefore opposites. The usual solution for a weakening economy is to cut interest rates, thereby making borrowing cheaper and, hopefully, stimulating more activity, but the usual cure for high inflation is to hike interest rates in order to rein in activity. These opposite ends of the scale – economic contraction versus inflation – are what central bankers typically try to balance when deciding where to set interest rates.

Tackling both together is therefore extremely difficult.

“In general terms, governments need to stimulate growth, through tax breaks and investment incentives,” said Sydenham.

The UK government is, for its part, trying to get the economy going. In the early weeks of 2025, chancellor Rachel Reeves visited China in order to improve trade relations with the country, while prime minister Keir Starmer announced plans to boost UK productivity through big investments in artificial intelligence (AI).

The problem is, things like this cost money (£14 billion in the AI investment case). That money either has to come out of public spending elsewhere, which could mitigate the positive impact it has on growth, or it could come from increased taxes, which would directly weigh on growth. Or, the government could try to increase its spending power and boost economic activity through quantitative easing, but this is inherently inflationary.

Often, approaches that address structural problems – such as improving training or increasing skilled immigration in order to address skills shortages – are the only ways to address stagflation.

How can you prepare for stagflation?

Kalpana Fitzpatrick, digital editor of MoneyWeek and author of Invest Now, said: “Persistent high inflation is not good news for cash savings, as the value of your cash can erode quickly if it can’t keep up with price rises.

“But it is still important to hold cash savings, especially during turbulent times. Everyone should look to hold onto at least six months’ worth of income as emergency cash savings. This is money you can use to help pay for unexpected costs – anything from losing your job to a broken boiler.”

Fitzpatrick added:“If you don’t have an emergency fund, now is the time to build one as we continue to face price rises and stagflation. Always keep emergency money in an easy-access savings account.

“If you have investments, stagflation could mean a squeeze on profit margins and you may see the value of your investments go down. Although this can cause concern, the key thing is not to panic or take your money out. Stock market ups and downs are normal in investing, and the best way to smooth out the returns is to continue drip-feeding small amounts into your investments each month and ride out the storm.”