From The Free Forex Encyclopedia
As the name suggests, stagflation is a period in time when there is a combination of high inflation and economic stagnation. In essence, it is characterized by rising unemployment and declining business production while the prices of goods and services get higher. Both stagnation and inflation magnify each other, causing economic conditions to worsen further.
One of the worst things that can occur to a currency is the effect of stagflation. It leaves very little room for central banks to move because it cannot raise interest rates enough to combat rising prices. When prices rise disproportionately to interest rates, the value of the domestic currency depresses. This, in turn, reduces the purchasing power of consumers. As such, foreign exchange markets usually see stagflation as negative for the domestic currency.