The UK economy is experiencing a taste of stagflation. This won’t be anywhere near as severe or as persistent as in the 1970s. But for the next six months, the worsening product and labour shortages will put the brakes on the economic recovery at the same time as higher energy prices drive up CPI inflation from 3.2% in August to a peak of around 5.0% in April next year. The Bank of England’s growing fear that some of this rise in inflation is becoming embedded within wage growth and inflation expectations means it is on the cusp of raising interest rates from 0.10% for the first time since the pandemic. The markets have priced in increases in interest rates to over 1.00% by the end of next year. Our forecast that economic activity will be weaker than the Bank expects over the next six months and that CPI inflation will fall back to the 2% target in late 2022 and in 2023 suggests that interest rates won’t rise that far that fast.
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