City economists warn Iran conflict could force Bank of England rate hikes
Analysts suggest sustained oil prices above $100 a barrel may trigger multiple interest rate increases, despite expectations that the Bank will hold rates at 3.75% this week.
City economists have cautioned that the Bank of England may be compelled to raise interest rates later this year if oil prices remain above $100 a barrel, a scenario driven by renewed conflict in Iran. While the Bank is widely expected to maintain its current rate of 3.75% at its monetary policy committee meeting on Thursday, analysts warn that sustained high energy costs could trigger inflationary pressures requiring multiple rate hikes.
The breakdown of a fragile ceasefire between the United States and Iran has sent oil prices back to the highs seen in April and May. A barrel of Brent crude jumped above $100 (£75) on Thursday before falling back to $96 on Friday, significantly higher than the $71 recorded earlier in the month. Gas prices have also soared ahead of the period when European countries refill storage facilities for winter heating demand.
Financial markets are signalling that oil prices at $90 would necessitate one and a half quarter-point hikes, while prices at $100 would require two 25 basis point hikes. Sanjay Raja, chief UK economist at Deutsche Bank, noted that upside risks to the interest rate outlook depend heavily on the duration of the unfolding energy shock. He warned that a second energy wave would likely amplify uncertainty around the inflation path and the risk of second-round effects.
Mohamed El-Erian, former chief economist at the International Monetary Fund, suggested that sustained oil prices above $90 a barrel could be enough to rewrite UK policymakers’ forecasts. He highlighted concerns over immediate indirect effects, including rising food prices driven by diesel transportation costs, and broader second-round effects over time. Ruth Gregory of Capital Economics added that a worst-case scenario, with inflation rising to 7 per cent, could see rates climb to 4.75 per cent.
Conversely, some experts argue the UK economy is too weak to sustain higher borrowing costs. Harvinder Kalirai of Alpine Macro stated that demand is not strong enough to sustain a pass-through from the energy shock, forcing firms to absorb higher input costs. He expects the Bank to look through the oil shock and political noise to hold rates steady for now before resuming cuts next year.
The Bank’s nine-member monetary policy committee is expected to vote 7-2 in favour of holding rates, echoing the June meeting where two officials voted for an increase. Meanwhile, the European Central Bank is anticipated to raise interest rates at its meeting on 10 September, having already raised rates in June for the first time since 2023 in response to inflation caused by the war in Iran.
Central banks have come under fire for considering an increase in the cost of borrowing, with critics arguing that higher rates will only exacerbate the economic situation. However, Costas Milas of the University of Liverpool argued that oil price shocks trigger long bouts of inflation and should be tackled quickly to prevent public dissatisfaction from worsening.
