Oil price surge pushes investors to bet against interest rate cut
Investors have pared bets that the Bank of England will cut interest rates in March, as analysts worry that the surge in oil and gas prices could prop up inflationary pressures in the economy.
European gas prices were up over 40 per cent on Monday while oil prices gained seven per cent to hover around $80 following a series of retaliatory Iranian strikes across the Middle East.
Many analysts feared that these increases could reinvigorate domestic inflationary pressures, delaying the pace of interest rate cuts.
“The spike in energy costs risks ending the period of disinflation in Europe and the US, which has helped to boost economic prospects on both sides of the Atlantic,” Kathleen Brooks, research director at XTB said.
Traders now put the odds of a rate cut later this month at a little under 50 per cent, down from nearer 86 per cent before the conflict erupted.
Markets fear the fallout
The combination of easing inflation and rising unemployment had increased the likelihood of a March rate cut, but markets now fear that the fallout from the conflict in the Middle East could derail the disinflationary progress.
If energy prices were to remain elevated for an extended period of time, then price pressures would spill over into other parts of the economy, economists warned.
“Energy typically makes up around 8–10 per cent of CPI baskets, but during major shocks, it can account for up to one-third to one-half of headline inflation — with indirect effects amplifying the impact further,” said Ipek Ozkardeskaya, senior analyst at Swissquote.
Paul Dales, chief UK economist at Capital Economics, suggested that the headline rate of inflation could be pushed up by around 0.5-0.6 percentage points as a result of the conflict.
“Given inflation is currently above target, inflation expectations are higher than before the pandemic, and the public’s inflation expectations tend to respond to changes in energy prices, the Bank of England is likely to be more sensitive to this than other central banks,” he said.
Inflation could spike if Hormuz Strait blocked
Fears about a new energy price shock come amid an intensifying conflict between the US, Israel, and Iran. Over the weekend, Donald Trump launched strikes across Iran, killing Supreme Leader Ayatollah Khamenei as well as a number of other high-ranking Iranian officials.
In response, crucial pieces of energy infrastructure across the Gulf were targeted by Iranian missiles on Monday, including the world’s largest LNG export plant in Qatar and the region’s largest oil refinery in Saudi Arabia.
Shipping through the Strait of Hormuz has also effectively ground to a halt too after the Iranian Revolutionary Guard warned that tankers passing through the crucial sea lane would be targeted. Roughly 20 per cent of global oil supply passes through the Strait.
The severity of the shock will depend on how long energy prices remain elevated, but extended disruption to the Strait of Hormuz would pose a major inflationary risk, experts warned.
“We are a long way off 2022 in terms of pricing yet, but if LNG to Europe is effectively shut via Hormuz for a prolonged period we could see chaos,” Neil Wilson, investor strategist at Saxo UK, said.
“I am much more concerned about European natural gas prices than oil prices in terms of seeing a repeat of the 2022 European energy crisis.”