Will the Middle East crisis push the UK into stagflation?

Stagflation is one of the most-feared words among economists and policymakers. With the UK struggling to revitalise growth, and with inflation proving stubborn, could the economy drift into a stagflationary period?

Inflation ran at 3.0% in the year to January 2026. The Bank of England aims for 2%, so while inflation is not out of control, it is well above the target.

The issue is that inflation measures are always backward-looking. Since the outbreak of conflict in the Middle East in early March, rising oil prices have all but guaranteed that the rate of inflation will rise.

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At the same time, the economy is weakening. UK GDP flatlined during January and only grew by 0.2% over the preceding three months. UK unemployment hit its highest level since 2021 in the final quarter of last year.

Again, this data reflects a period before the war broke out. It is highly likely that higher energy costs will also have restricted economic activity since the beginning of March.

This combination of sluggish growth and stubborn inflation is known as stagflation – a portmanteau of ‘stagnation’ and ‘inflation’.

“A prolonged conflict risks pushing the country towards something resembling an energy shock – higher inflation and weaker growth, a toxic mix of stagflation that damages both corporate performance and household budgets,” said Rob Morgan, chief investment analyst at wealth manager Charles Stanley.

How does stagflation occur?

Stagflation arises when there are rising prices in an economy, but no growth or stagnation. It poses a conundrum for policymakers largely because it confounds the usual fiscal logic. Prices shouldn’t go up when people have less money to spend.

“Generally, inflation is accompanied by growth, as salaries and prices usually rise in response to growing demand,” said Jane Sydenham, investment director at Rathbones Investment Management.

“Stagnation is damaging, because costs rise, but there is no growth to compensate for rising costs, and so the economy becomes less productive”.

The UK’s current stagflationary predicament arises from several adverse supply shocks over recent years, including Brexit, the Covid pandemic, rising energy prices and hikes to National Insurance contributions.

“The scarring from these shocks has lifted inflation expectations, contributing to sticky pay growth, and led to heightened uncertainty, creating a desire for higher precautionary savings and discouraging investment,” said Michael Saunders, senior economic advisor at Oxford Economics and a former Monetary Policy Committee (MPC) member at the Bank of England

“The scarring from these shocks has lifted inflation expectations, contributing to sticky pay growth, and led to heightened uncertainty, creating a desire for higher precautionary savings and discouraging investment,” he said.

That lack of investment – as well as the higher interest rates required to restrain inflation – have acted as a brake on consumer spending, which is further hampering economic growth.

To reiterate, this describes the UK economy before the Iran War. The picture for the year ahead is looking increasingly grim.

“Back in November 2025, the OBR expected the economy to grow by 1.4% in 2026, up slightly from the previous year’s 1.3%. That forecast has since been revised to 1.1% in the spring statement as a cooling labour market weighed on the outlook,” said Morgan.

“And this downgrade does not account for the potential inflation shock now building. If oil and gas prices remain elevated for an extended period, growth risks falling significantly short of even these low expectations.”

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 spending.

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.

Central banks, meanwhile, need to tread a very careful line between stifling growth and fueling inflation.

Ahead of the outbreak of the conflict, most experts had anticipated that the MPC would continue with a gradual rate-cutting policy this year, but that now looks less likely given the prospect of higher energy prices and the knock-on inflationary effect.

“Though talk of rate rises is premature as policymakers will likely look through the immediate impact of surging energy prices, interest rate cuts will probably remain off the table until the Autumn at the earliest, even if a swift resolution to the crisis is found,” said Suren Thiru, chief economist at the Institute of Chartered Accountants in England and Wales.

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.”

Raymond Backreedy, chief investment officer at Sparrows Capital, echoes these points and stresses the importance of diversification.

“One should remain invested and allocate according to the strategic asset allocation that best suits the end investor risk appetite, drawdown and tolerance for loss,” he told MoneyWeek. “We emphasise a globally diversified multi asset portfolio, where the main return/risk drivers are from listed equities and defensive assets are from high quality global sovereign short to mid duration bonds.”