Explaining the Economic Ripple Effects of the Iran War
There is nothing quite like being asked to explain to the British public on Nicky Campbell's Five Live show why missile attacks on an Iranian oil field create a domino effect that reverberates through the mortgage markets.
Hearing directly from farmers rationing their red diesel or homeowners having their mortgage offers withdrawn brings the charts and numbers vividly to life.
Not a single molecule of Iranian gas is exported to the UK, so the speed and intensity of these shockwaves are astonishing, especially for someone who has been covering efforts to control inflation for over 25 years.
Insights from the Bank of England Governor
I have just emerged from the Bank of England where I interviewed the governor on behalf of broadcasters. The key takeaway is that the Bank did not cut interest rates, contrary to the clear expectations before the war began. Additionally, inflation will not now fall to the 2% target as had been anticipated prior to the conflict.
The Bank's forecasters indicated that inflation could reach 3.5% in the coming months based on Wednesday's oil and gas prices. Should Thursday's spike in oil and gas prices persist, inflation could rise even further.
The markets reacted strongly to the Bank of England's decision to hold rates steady. Long-term interest rates on UK government debt surged, suggesting investors were betting on two or even three rate hikes this year. This appeared to be an overreaction.
However, the near-term outlook for the UK economy could be completely altered by events thousands of miles away.
Changing Economic Trajectory and Inflation Outlook
There were signs, even as late as Thursday morning's jobs figures, that the economy was about to turn a corner—if not for the energy price shock. Interest rate cuts and falling inflation were part of that emerging picture.
That scenario is no longer viable, as the governor noted, pointing out that inflation is not expected to hit its target. Clearly, inflation will be higher, especially as gas prices are passed on to households in July. The critical questions remain: how high will inflation rise, and what level of economic damage will result?
Governor’s Caution on Market Expectations
In my conversation with the governor, he emphasized that markets were "getting ahead" of themselves by assuming multiple rate increases.
"I would caution against reaching any strong conclusions about raising interest rates," he said.
"Today we've given a very clear message. The right place to be is on hold."
He added that the Bank would monitor the extent and severity of the conflict "carefully, continuously."
The governor also sought to reassure the public that this situation is not a repeat of the energy shock of 2022 when Russia invaded Ukraine. Interest rates are already higher than they were then, and although inflation is expected to be higher than previously forecast, it is not anticipated to reach the double-digit levels experienced four years ago.
"The context is actually very different. I don't expect inflation to go up in that way," he told me.
Bank of England’s ‘Wait and See’ Approach
Describing the Bank as being in "wait and see" mode understates the situation. Raising or cutting interest rates will not repair Qatar's gas facilities or unblock the Strait of Hormuz. Like everyone else, the Bank is awaiting clarity on developments in the six weeks before its next meeting at the end of April.
In just three weeks, the war has overturned what was a likely rate cut, sent inflation off course, increased the effective interest rates paid by the government, and caused a fundamental repricing of fixed-rate mortgages, impacting parts of the housing market.
It is no surprise that both the governor and the chancellor are calling for de-escalation.
