Israel's War with Iran Threatens to Keep Interest Rates Higher for Longer

The recent surge in oil prices following Israel's strike on Iran has put the Bank of England's inflation forecasts to the test, with economists warning of a potential re-ignition of inflation and a possible wage-price spiral. Robert Wood, at Pantheon Macroeconomics, has stated that events in the Middle East are a reminder of the vulnerability of the Bank's forecasts, and that oil prices have risen from $65 per barrel to around $74 over the last week. This increase threatens to push British inflation closer to 4pc this year, double the Bank's 2pc target.

Key Takeaways:

• Oil prices have risen from $65 per barrel to around $74 over the last week, threatening to push British inflation closer to 4pc this year.
• The surge in energy costs could ignite another wage-price spiral, as workers demand bigger pay packets to compensate for higher bills.
• The Bank of England's Governor, Andrew Bailey, and the MPC are expected to keep rates on hold at 4.25pc on Thursday before cutting borrowing costs in August to take the headline rate to 4pc.
• However, economists Robert Wood and George Buckley warn that events in the Middle East and potential higher natural gas prices could force officials to hold borrowing costs at 4pc to stop inflation from spreading through the economy.
• The economy has shown signs of weakness, with the job market also showing signs of weakness, making it harder for the Bank's officials to decide the most appropriate level of interest rates.
• Michel Nies, at Citi, suggests that the conflict may push some MPC members to recalibrate their stance on interest rates, potentially leading to a more neutral position.

Statistics:

• Oil prices have risen from $65 per barrel to around $74 over the last week.
• Inflation rose to 3.4pc in April, the highest level in more than a year.
• The Bank expects to eventually take the base rate down to 3.5pc over the next year.
• The economy shrank in April.
• 5 MPC members voted for a 0.25 percentage point cut in May.

Sources:

• [1] Robert Wood, Pantheon Macroeconomics, interview with the press.
• [2] George Buckley, Nomura, economist.
• [3] Michel Nies, Citi, article.