The Bank of England could be forced to cut its economic forecasts and raise interest rates later this year if oil prices return above $100 a barrel, according to City economists.
Ahead of a meeting of bank officials on Thursday, economists said that while an interest rate hike would be avoided this week, something could happen in the future due to conflicts in the Middle East.
Economists added that Britain’s economy has been relatively stable since Donald Trump’s war on Iran began in March, but could be at risk after hostilities resumed last week.
The breakdown of a fragile ceasefire between the US and Iran sent oil prices back to the highs of April and May, raising fears that higher prices at the pumps would fuel inflation.
Brent crude fell from $100 a barrel (£75) on Thursday to $96 a barrel on Friday, well above the $71 a barrel it hit earlier this month.
Gas prices have risen ahead of the critical period when most European countries refill their storage facilities in time for winter heating demand.
All major central banks say they are concerned about the impact of war in the Middle East and its impact on rising prices.
The bank’s nine-member monetary policy committee is expected to vote to keep interest rates on hold on Thursday, keeping them at 3.75 percent by a seven-to-two margin until at least December. It echoes their last meeting in June, when two committee officials voted to raise rates to curb rising inflation.
Sanjay Raja, Deutsche Bank’s chief UK economist, said the calculus could change if the intensity of airstrikes continued and the sea lanes that allow tankers to enter and exit oil terminals remained closed.
He said: “We see upside risks to the interest rate outlook in the near term, largely dependent on the timing of the energy shock. A second energy wave will likely increase uncertainty around the path of inflation and the risk of second-period effects.”
George Buckley, Nomura’s chief UK and euro area economist, said financial markets were giving clear signals that higher oil prices would lead to higher interest rates. “At $90 they would see a need for a quarter-and-a-half point increase. At $100 they would need two 25 basis point increases,” he said.
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University of Pennsylvania professor and former International Monetary Fund chief economist Mohammad Al-Arian suggested that a sustained rise in oil prices to $90 a barrel could be enough to rewrite UK policymakers’ forecasts.
He said: “If oil prices stay above $90 a barrel, which is a significant ‘if’, then headline inflation will face significant upward pressure. As a result, there will be concerns over immediate indirect effects, including rising food prices due to diesel transport costs, and broader second-round effects over time.”
“As a result market expectations of a Bank of England rate hike will increase, even as higher energy prices act as a tax on economic activity.”
A worst-case scenario suggests UK interest rates will rise to 4.75% from 3.75% if inflation rises to 7% in the coming months in response to the Middle East conflict, said Ruth Gregory, deputy chief UK economist at Capital Economics.
Harvinder Kalarai, chief global currency strategist at Alpine Macro, a division of Oxford Economics, said he expected the bank to “look at oil shocks and political noise” to keep rates steady before resuming cuts next year.
He said the UK was not strong enough to withstand rising fuel prices and high interest rates: “Demand is not strong enough to sustain the energy shock, forcing firms to absorb higher input costs.”
Once the volatile elements of the inflation basket – including fuel and food – were excluded, prices rose slowly while pay packets rose at a slower pace, Kilrai said.
Costas Meles, professor of economics at the University of Liverpool, said oil price shocks trigger long inflationary shocks and should be dealt with quickly.
He said: “It is very painful for the BoE to remain inactive because the public remains dissatisfied with the BoE. As dissatisfaction increases with inflation, the BoE should raise interest rates as soon as possible, possibly as early as September.”
David Ackman, head of the National Institute of Economic and Social Research, said: “The longer inflation remains above target, the greater the change in inflation expectations and the greater the expectation of change in wages – and so the Bank needs to raise rates.”
Financial markets also expect a hike at the next meeting of the European Central Bank’s Governing Council on September 10. It raised interest rates for the first time since 2023 in June in response to war-induced inflation in Iran.
Central banks have come under fire for considering raising borrowing costs, with critics saying a rise in interest rates would worsen the situation.
