Economists warn oil surge could force Bank of England rate hikes

BOE expected to hold rates as oil surge tests inflation outlook

The Bank of England’s nine-member Monetary Policy Committee is expected to vote to keep the key interest rate at 3.75% on Thursday, extending a pause that began after the outbreak of the Iran war in March. In its June meeting, two members dissented in favor of a rate increase to preempt rising inflation tied to the conflict.

The renewed fighting in the Middle East has scrambled that relatively steady outlook. Brent crude rose above $100 a barrel last week before settling at $96, up sharply from $71 at the start of July. Natural gas prices have also surged as European countries approach the winter storage refill season.

George Buckley, chief UK and euro area economist at Nomura, said financial markets were giving a clear signal that higher oil prices would mean 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.

Ruth Gregory, deputy chief UK economist at Capital Economics, said a worst-case scenario showed that if inflation rose to 7% in response to the conflict, “UK interest rates would probably rise from 3.75% to 4.75%.”

Sanjay Raja, chief UK economist at Deutsche Bank, said the calculus depends on the duration of the energy shock. “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,” he said.

Mohamed El-Erian, a professor at the University of Pennsylvania and former chief economist at the International Monetary Fund, said sustained oil above $90 a barrel would put significant upward pressure on inflation and heighten market expectations of a BOE hike, even as higher energy prices act as a “tax on economic activity.”

Costas Milas, an economics professor at the University of Liverpool, said the Bank should act soon. “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,” he said.

David Aikman, head of the National Institute of Economic and Social Research, said the risk grows with time. “The longer inflation remains above target, the greater the chance inflation expectations shift and wages respond — and hence the Bank needing to hike,” he said.

Harvinder Kalirai, chief global currency strategist at Alpine Macro, offered a contrasting view, arguing the Bank would “look through the oil shock and political noise” to hold rates steady before resuming cuts next year. He said UK demand is not strong enough to sustain a pass-through from the energy shock, forcing firms to absorb higher input costs.

The European Central Bank is under similar pressure. Markets anticipate a rate hike at its September meeting, following the ECB’s June increase — its first since 2023 — driven by inflation concerns linked to the Middle East conflict.