Rising oil prices could force up UK interest rates, say economists
Economists warn that the Bank of England may have to raise interest rates later this year if oil prices return above $100 a barrel, despite an expected hold at the upcoming meeting.
City economists have warned that the Bank of England could be compelled to overhaul its economic forecasts and increase interest rates later this year if oil prices climb back above $100 a barrel. Ahead of the Bank's meeting on Thursday, experts say that while a rate hike is unlikely this week, future increases may be driven by the conflict in the Middle East.
The UK economy has shown relative resilience since Donald Trump’s war with Iran began in March, but this could be at risk after fighting reignited last week. The collapse of the fragile US-Iran ceasefire sent oil prices back to highs seen in April and May, sparking fears that higher pump prices would fuel inflation.
Brent crude briefly jumped above $100 a barrel on Thursday before falling back to $96 on Friday, well above the $71 recorded earlier this month. Gas prices have also surged ahead of the crucial period when most European countries refill storage for winter heating demand.
Sanjay Raja, chief UK economist at Deutsche Bank, said that calculation might change if airstrikes continue and sea channels for tankers remain blocked. He noted upside risks to the interest rate outlook in the near term, depending on the duration of the energy shock.
George Buckley of Nomura added that financial markets are clearly signalling that higher oil prices translate into higher rates: at $90 a barrel, one and a half quarter-point hikes would be needed; at $100, two 25-basis-point increases.
Mohamed El-Erian, former chief economist at the IMF, suggested a sustained rise to $90 could be enough to rewrite policymakers' forecasts, putting upward pressure on headline inflation and raising concerns about indirect effects like food prices driven by diesel costs.
Ruth Gregory of Capital Economics said a worst-case scenario where inflation hits 7% could force UK rates from 3.75% to 4.75%. Harvinder Kalirai of Alpine Macro, however, expects the Bank to look through the oil shock and hold rates steady before resuming cuts next year, arguing that demand is not strong enough to sustain a pass-through.
The Bank's Monetary Policy Committee is expected to vote 7-2 to hold rates at 3.75% on Thursday, with a hold seen until at least December. Costas Milas of the University of Liverpool warned that oil price shocks trigger long bouts of inflation and should be tackled quickly.
Financial markets also anticipate a rate hike at the European Central Bank's next meeting on 10 September, after it raised rates in June for the first time since 2023 in response to Iran-related inflation.
