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The Bank of England could be forced to tear up its economic forecasts and raise interest rates later this year if oil prices return to above $100 a barrel, according to City economists.
Before a meeting of Bank officials on Thursday, economists said that while an interest rate hike would probably be avoided this week there could be some in the future because of conflict in the Middle East.
The UK economy has remained relatively resilient since Donald Trump’s war on Iran began in March, but this could be at risk after fighting reignited last week, the economists added.
The breakdown of the fragile ceasefire between the US and Iran sent oil prices back to the highs seen in April and May, sparking fears that higher prices at the pumps would send inflation soaring.
A barrel of Brent crude jumped above $100 a barrel (£75) on Thursday before falling back to $96 on Friday, well above the $71 recorded earlier this month.
Gas prices have soared before the crucial period when most European countries refill their storage facilities in time for winter heating demand.
All the major central banks say they are concerned about the impact of the war in the Middle East and its influence on rising prices.
The Bank’s nine-member monetary policy committee is expected to vote on Thursday in favour of holding interest rates, and to continue maintaining them at 3.75% until at least December, by a margin of seven to two. This echoes their last meeting in June when two officials on the committee voted to increase rates to head off rising inflation.
Sanjay Raja, the chief UK economist at Deutsche Bank, said that calculation might change if the intensity of airstrikes was maintained and the sea channels allowing tankers to enter and exit oil terminals remained blocked.
He said: “We see upside risks to the interest rate outlook in the near term, with much dependent on the duration of the unfolding energy shock. A second energy wave will likely amplify uncertainty around the inflation path and the risk of second-round effects.”
George Buckley, the chief UK and euro area economist at Nomura, said financial markets were giving a clear signal that higher oil prices would translate into higher interest rates. “At $90 they would see the need for one and a half quarter-point hikes. At $100 there would be a need for two 25 basis point hikes,” he said.
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Mohamed El-Erian, a professor at the University of Pennsylvania and a former chief economist at the International Monetary Fund, suggested a sustained increase in oil prices to $90 a barrel could be enough to rewrite UK policymakers’ forecasts.
He said: “Should oil prices remain above $90 a barrel, an important ‘if’, then headline inflation would face significant upward pressure. This, in turn, would heighten concerns over immediate indirect effects, including rising food prices driven by diesel transportation costs, and broader second-round effects over time.
“The result would be heightened market expectation of a Bank of England rate hike, even as higher energy prices act as a tax on economic activity.”
Ruth Gregory, the deputy chief UK economist at Capital Economics, said a worst-case scenario showed that if inflation rose to 7% over the coming months in response to the Middle East conflict, UK interest rates would probably rise from 3.75% to 4.75%.
Harvinder Kalirai, the chief global currency strategist at Alpine Macro, a division of Oxford Economics, said he expected the Bank to “look through the oil shock and political noise” to hold rates steady for now before resuming cuts next year.
He said the UK was not strong enough to withstand a rise in the cost of fuel and higher interest rates: “Demand is not strong enough to sustain a pass-through from the energy shock, forcing firms to absorb higher input costs.”
Kalirai said once volatile elements of the inflation basket – including fuel and food – were excluded, prices were growing slowly while pay packets were rising at a slower pace.
Costas Milas, an economics professor at the University of Liverpool, said oil price shocks triggered long bouts of inflation and should be tackled quickly.
He said: “This is too uncomfortable for the BoE to stay inactive not least because the public remains dissatisfied with the BoE. Since dissatisfaction increases with inflation, the BoE should act soon by raising interest rates, possibly as early as September.”
David Aikman, the head of the National Institute of Economic and Social Research, said: “The longer inflation remains above target, the greater the change inflation expectations shift and wages respond – and hence the Bank needing to hike rates.”
Financial markets also anticipate a hike at the European Central Bank governing council’s next meeting on 10 September. It raised interest rates in June for the first time since 2023 in response to higher inflation caused by the war in Iran.
Central banks have come under fire for considering a rise in the cost of borrowing, with critics arguing increases in interest rates will only make a bad situation worse.
