Iran war likely to prevent BoE from cutting rates as previously anticipated

Until the US and Israel started bombing Iran less than three weeks ago, it was viewed as a near certainty that the Bank of England would cut interest rates again on Thursday. Now it's a near-certainty that it will leave its base rate unchanged at 3.75 per cent.

The start of the Iran war on February 28 set in a chain of events that has done much to upend global economic forecasts, not least in how it will affect prices. The longer the Iran war and the associated closure of the Strait of Hormuz go on, the greater the economic pain will be. A fifth of the world's crude oil goes through the strait.

 

The most tangible impact has been in oil and gas markets, with prices rising sharply higher since the start of the war. That has already had an impact on prices at the pump and will, if sustained, lead to higher domestic energy bills.

With these new inflationary pressures stalking the global economy, central bankers are having to reassess their projections in 2026, both for inflation and growth. On Wednesday evening, the US Federal Reserve held its key interest rate unchanged, as expected.

For the Bank of England, it's likely to mean that inflation will not fall to its target rate of 2 per cent as soon as expected and will lead to a higher price profile for the rest of the year - hardly the backdrop for further interest rate reductions anytime soon.

"The bank would be wise to wait and see whether a rise in energy prices triggers a re-acceleration of underlying price pressures before acting," said Andrew Wishart, UK economist at Berenberg Bank.

Wishart said the bank's nine-member Monetary Policy Committee could cut its main interest rates from the current 3.75 per cent as soon as June - provided the closure of the Strait of Hormuz is short-lived.

"If energy prices stay high for six months, the bank would probably delay the reduction until 2027," he added.

After last month's rate-setting meeting, financial markets were predicting at least two to three quarter-point reductions in the base rate this year. Economic projections accompanying the decision to keep rates unchanged then showed inflation hitting the target in the spring. But the bank's governor, Andrew Bailey, said "all going well," there should be scope for some further cuts this year.