I raised the issue with Parallels support who provided the following instructions, which *so far* seem to have sorted the issue for me:
1.0. Start Parallels Desktop. Make sure that the virtual machine is shut down. If it is in a suspended state, please run it and then immediately shut down (Actions > Shut Down).
1.1. Perform a soft restart of your Mac (Apple Logo > Restart). It is quite important. If a soft restart fails at first (macOS gets stuck and does not reboot), perform a hard reset using power button followed by a soft restart.
1.2. In Mac macOS, run Terminal and execute the command below:
prl_disk_tool check --hdd /Users/Shared/Parallels/Windows\ 10.pvm/Windows\ 7-0.hdd
If you pvm has different name or location, modify above command accordingly. A simple way to do that is type the first part of the command including a space at the end like this
prl_disk_tool check --hdd
then, in Finder, drag your pvm and drop on the terminal window.
1.3. Wait till the operation finishes. It may take a while (mine took a few hours).
The progress % may get stuck at some point, but the process is actually working. You can see it if you open Activity monitor, go to Disk tab and in the search bar type "prl", you will see a "prl_disk_tool" process, and the number of "Bytes read" slowly rising.
2.1 Once the process finishes (prl_disk_tool will disappear from the activity monitor), run the virtual machine. If the issue persists, please raise issue with Parallels support.
2.2 Once booted, click on the Windows icon (left bottom) and type 'cmd'
2.3 'Command prompt' will appear in suggestions. Right-click on it > Run as administrator > Yes.
2.4 Paste the following command into the prompt:
chkdsk C: /f /r /x
2.5 Press return to execute the command.
2.6 It will ask 'Would you like to schedule this volume to be
checked the next time the system restarts? (Y/N)'. Type 'Y' and press return.
2.7 Restart Windows (Windows icon > Power icon > Restart).
After that, please, do not touch mouse or keyboard, otherwise Windows might cancel the disk check. Once it is initiated, it might take from 5 minutes to an hour depending on the disk's condition.
Once the operation is complete, boot into Windows and see if performance has improved.