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Bank of England likely to hold interest rates as Iran conflict fuels energy shock - YAHOO FINANCE
UK interest rates could go back above 4% if energy shock persists
Bank of England interest rates were widely expected to be cut this month, but surging oil and gas prices linked to the Middle East conflict have shifted market expectations towards a hold, with economists warning borrowing costs could rise above 4%.
The central bank held rates at 3.75% last month in a narrow 5-4 vote, but the war in Iran has cast doubt over its ability to deliver further cuts. Traders have sharply reduced their bets on a rate reduction later this month, from an 86% chance on Friday to just 27% today, after the Middle East conflict triggered the sharpest oil (BZ=F, CL=F) and gas (NG=F) shock since Russia invaded Ukraine in 2022. Money markets now expect only one more cut this year, from 3.75% to 3.50%, down from two last week.
The National Institute of Economic and Social Research (NIESR) said higher energy prices could push inflation higher and raise borrowing costs. Ben Zaranko, from the Institute for Fiscal Studies, added that rates may need to rise to keep inflation in check, noting that the Office for Budget Responsibility’s modelling suggests the Bank of England could be forced to raise borrowing costs.
Ed Cornforth, an economist at NIESR, said: “The conflict in the Middle East will have material implications for the economic outlook. The Bank of England will have to contend with a shock to global energy prices, with the question of persistence hanging over their heads.”
Zaranko added he would not “rule out” a rate increase to 4% as the BoE's next move. “In the short term, what we might see is rather than rates go up it might just mean rate cuts we might otherwise have experienced don’t happen,” he said.
Oil and gas prices have jumped since the US-Israel war with Iran intensified, disrupting supplies. Iran has threatened to block the Strait of Hormuz, while Qatar halted liquefied natural gas (NG=F) production following attacks on its plants. Brent crude (BZ=F) has risen about 15% since the fighting began, and European natural gas prices have soared by roughly three-quarters.
James Smith, developed markets economist at ING, said: “Investors have slashed expectations for a March rate cut from the Bank of England. Markets are pricing it with just a 20% probability, down from 80% pre-conflict. We now expect the next cut in April, though March remains possible if tensions rapidly de-escalate. With the jobs market still under pressure, further easing is still more likely than not.”
David Rees, head of global economics at Schroders, said rising energy prices could offset the impact of the April budget and give the BoE pause. “If higher energy prices squeeze real incomes and prevent the bank from cutting rates, hopes for a growth pick-up could be dashed, potentially forcing action from the chancellor later this year,” he said.
