Only the Middle East crisis prevents a fall in interest rates in the United Kingdom
There is the threat of high inflation coming to the UK, but only because of the conflict in the Middle East, which could keep oil prices high for much longer than expected when Donald Trump began attacking Iran.
It is war that makes the difference between a benign outlook for inflation and one that puts it back on an upward trajectory, senior UK central bankers believe.
The Bank of England’s monetary policy committee was clear in its decision on Thursday to keep interest rates at 3.75% that underlying pressures on inflation are almost entirely absent from the domestic economy. Prices are stable and, without the war, would rise steadily if the central bank’s 2% target was met.
Threadneedle Street officials worry that retail prices will rise if companies find a way to raise them, taking advantage of a general expectation among consumers that the war has raised production costs. They also fear that workers will see another rise in inflation coming and propose a significant increase in wages.
They haven’t seen any of these trends yet. If anything, the opposite is true and the indirect or secondary effects of rising energy and transport costs remain weak.
Supermarkets have shown resilience and kept food inflation low. Utilities, long a source of price increases after the pandemic, have managed to restrain increases this year.
As the Bank’s quarterly review says: “So far, there are few signs of second-round effects. But there is not yet enough evidence to rule out this risk, and the MPC will continue to monitor the evidence closely.”
Annual wage increases are low across the private sector, at 2.8% in the second quarter of this year. They are expected to rise to 3% in the third quarter, but that increase keeps pay increases at a level that Bank officials are comfortable with.
As for companies taking advantage of a period of rising prices, whether it affects them or not, official data does not show that happening in the manufacturing, construction or service industries.
The three MPC members who voted in favor of raising the cost of borrowing this month acknowledge that neither workers nor businesses have reacted to inflation. They argue that the figures we have seen – the latest of which is the consumer price index (CPI) falling to 2.6% in June – are a reflection of the cost pressures, or more precisely the lack of them, at the beginning of the conflict. Once prices start to rise again, workers and businesses will surely react, they argue, bringing inflationary pressures to the UK economy even if the Middle East war is resolved.
The majority of the MPC focused more on the labor market and the rise in unemployment and the sharp fall in vacancies over the last three years. They also see that financial markets have reacted by raising mortgage and commercial loan rates, tightening the screws on homebuyers and businesses without the Bank taking any action.
In any case, companies that want to invest and thereby employ more people could use a boost thanks to lower interest rates.
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The only thing standing in the way is Donald Trump’s failure to achieve a way out of the Middle East crisis.
Bank forecasters expect inflation to peak at 3.2% next spring, but say it could be much higher, at 4.1%, if the war persists and Brent crude prices rise above $100 a barrel again and stay there.
The National Institute for Economic and Social Research said this week that the UK had already lost the equivalent of £28 billion in growth this year as a result of the Middle East conflict.
The Bank’s warning that it may need to raise rates if the war continues means the impact on businesses, consumers and mortgage borrowers could, unless Trump backs down, be much more severe.
