Businesses across the UK are grappling with the fallout from the recent Budget, painting a concerning picture for 2025 and beyond. For labour-intensive sectors like hospitality and retail, the combination of increased National Insurance contributions, a higher minimum wage, and rising business rates presents a significant cost burden. While some businesses may offset these increases through price hikes, many others face intense competition or consumer resistance, leaving them with limited options.
The consequences for these struggling businesses could be severe. Job losses, particularly among part-time workers, may become necessary for survival, leading to a decline in overall output and a rise in unemployment. Already thin profit margins for many companies are likely to be further eroded, increasing the risk of business closures. This "triple whammy" of increased costs, as the Confederation of British Industry (CBI) describes it, undermines profitability and severely hampers investment, directly contradicting the government's growth targets.
This confluence of lower output, higher unemployment, and cost-push inflation aligns precisely with the classic definition of stagflation â a challenging economic scenario that presents a considerable dilemma for the Bank of England (BoE). The central bank faces a difficult choice: tighten monetary policy by raising interest rates to curb inflation's second-round effects, or succumb to political pressure to maintain low interest rates, thereby providing short-term relief to businesses and mortgage holders.
The latter approach, however, carries significant risks. Low interest rates could fuel excessive debt, potentially leading to higher long-term interest rates and borrowing costs. Furthermore, it risks decoupling public inflation expectations from the BoE's target, making it significantly harder to control inflation. This mirrors the conundrum faced by central banks globally in 2021-22, when post-pandemic economic rebounds and soaring energy prices following the Russian invasion of Ukraine were initially misjudged as "transitory." The resulting inflationary surge caused widespread economic and political upheaval, with governments losing elections and consumers enduring lasting financial hardship, including a 25% increase in UK food prices compared to two years ago.
Despite these recent lessons, neither central banks nor governments seem to have fully learned from this experience. The US Federal Reserve, for example, is expected to continue lowering rates towards its target "neutral" level of around 2.5 per cent. While this may be a long-term equilibrium, inflation dynamics operate on a much shorter timescale. The Fed must reassess its approach considering potential inflationary pressures from US President Trump's policies, including import tariff increases, potential reductions in the labour supply, and expansionary fiscal policies.
In the UK, the BoE's Monetary Policy Committee (MPC) considers the current interest rate of 4.75 per cent "restrictive," suggesting further cuts are possible. However, this hinges on the assumption that service sector inflation (currently at 5 per cent) will decrease despite rising input costs. The recent Budget, with its £70 billion increase in public spending including public sector pay settlements, adds to the complexity. The Office for Budget Responsibility estimates this will add £28 billion to government borrowing, even after tax increases. Further hindering growth prospects is the pressure on private sector profitability, eroding confidence and investment. External risks, such as volatile energy prices due to geopolitical instability in the Middle East and continued conflict in Ukraine, alongside potential US tariff threats, further complicate the situation.
With the MPC already forecasting a modest increase in inflation in the coming months, a fundamental re-evaluation of monetary policy is crucial. The risks of a renewed inflationary surge are too significant to justify further interest rate cuts while inflationary pressures remain so strong. The UK faces a stark choice: address the looming stagflation threat decisively, or risk a prolonged period of economic instability and hardship.