Tim Wallace
3 min read
Israel’s war with Iran threatens to keep interest rates higher for longer as the Bank of England struggles to control inflation, economists have warned.
A surge in oil prices since Israel struck Iran risks reigniting inflation and has exposed the vulnerability of the Bank’s forecasts, said Robert Wood, at Pantheon Macroeconomics.
“Events in the Middle East driving up oil prices last week are a reminder of just how close to the wind the MPC [Monetary Policy Committee] is sailing,” he said.
Oil prices have risen from $65 per barrel to around $74 over the last week in a move that threatens to push British inflation closer to 4pc this year, double the Bank’s 2pc target.
Mr Wood warned that the jump in energy costs could also ignite another wage-price spiral, as workers demand bigger pay packets to compensate for higher bills.
Andrew Bailey, the Bank’s Governor, and the rest of 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.
Investors currently expect the Bank to eventually take the base rate down to 3.5pc over the next year. However, Mr Wood warned that events in the Middle East could force officials to hold borrowing costs at 4pc to stop inflation from spreading through the economy.
“We find it far from implausible that inflation ends next year above 3pc if events in the Middle East worsen, or a cold winter boosts natural gas prices,” Mr Wood said.
Inflation rose to 3.4pc in April, the highest level in more than a year.
George Buckley, economist at Nomura, said: “We have had an energy shock in the past and look where it led us: to a whopping increase in inflation across the board, not just for energy, which did require a monetary policy response.”
However, Mr Buckley said the impact of conflict in the Middle East may be mixed, with higher oil prices leading to more expensive petrol, but also potentially prompting businesses to hold off investment. This would slow the economy and reduce upward pressure on inflation.
The economy shrank in April and the job market has shown signs of weakness, meaning the Bank’s officials face conflicting signals that make it harder to decide the most appropriate level of interest rates.
Michel Nies, at Citi, said the conflict “and the associated changes in energy prices, shipping costs and risk sentiment will remind MPC members of the volatility and unpredictability of the operating environment”.
He said it may push some MPC members who voted to cut rates in May to prompt for a pause this week.
