Economy unexpectedly flatlined forward of Iran warfare stoking stagflation fears and slashing odds of rate of interest reduce

The economy unexpectedly stalled in January ahead of the war in Iran, which is likely to weigh on growth amid fears of another cost-of-living crisis.

In January, the economy recorded zero growth, according to figures published by the Office for National Statistics (ONS). Most economists had expected growth of 0.2 per cent.

It underscores the economy’s fragility even before the outbreak of the Iran conflict, which has triggered an energy shock likely to raise inflation.

The prospect of another energy crisis has stoked fears that the UK will fall into a period of stagflation – the combination of higher inflation and unemployment, and stagnating growth – which has further dampened the chances of rate cuts.

The ONS said the overall picture is ‘subdued,’ led by zero growth across services and a 0.1 per cent fall in production in January. While construction grew 0.2 per cent in January, it continued its contraction over the quarter, down 2 per cent.

The figures will be grim reading for the Chancellor, who has pinned her hopes on improving economic growth. 

She said the figures come ‘amid an uncertain world’ but insisted, ‘Our economic plan is the right one, but I know there is more to do,’ as the Middle East conflict threatens higher inflation.

Economists at ING anticipate a peak for headline inflation in late summer at around 3.5 per cent.

‘The problem facing the UK is that despite the government saying they need to stick to the plan to produce economic growth, forecasts point to very little improvement, with even 2 per cent growth a year becoming a pipe dream,’ said Lindsay James, investment strategist at Quilter.

Today’s figures follow a tepid end to 2025, which saw growth of just 0.2 and 0.1 per cent in November and December, respectively.

While the economy managed to avoid recession last year, the Office for Budget Responsibility (OBR) downgraded 2026’s forecast for growth. Since then, the conflict has escalated and experts fear that a prolonged war will heap pressure on households and businesses and, therefore, growth.

‘Stagnation in January would make us worried about growth this year, even without the energy price shock that will start to show up in the March data,’ said Thomas Pugh, chief economist at RSM.

March rate cut chances have ‘evaporated’

The Bank of England was widely expected to cut rates at its meeting next week before the start of the war, but they are likely to delay this as they assess the impact of an energy shock.

Weaker growth and a fragile labour market will mean the central bank ‘faces an uncomfortable trade-off,’ said Deutsche Bank. ‘This is not 2022. The MPC will need to navigate these trade-offs carefully to avoid dragging the UK into a more protracted downturn.’

BofA Global Research, which had expected the BoE to cut rates in March, has pushed its call to June because of rising energy prices. 

Berenberg also believes the Bank will overwhelmingly vote to hold rates in March but, ‘once energy prices fall back, or it becomes clear that demand is soft enough for underlying disinflation to continue despite higher energy prices, we expect the BoE to resume interest rate cuts.’

Traders had bet on chances of an increase in the central bank rate last week, but ING says the bar to do this is high.

‘The 2022 playbook suggests it should tighten policy if the energy shock is enduring, in a bid to contain inflation expectations and the indirect fallout on services inflation. But with a weaker jobs market, that feedback mechanism is likely to be much more muted,’ it said.

‘We therefore think the bar for the Bank of England to hike rates is high. But the longer energy prices stay elevated, the longer the Bank is likely to stay on pause. The prospect of a March rate cut has all but evaporated.’