Setting a high bar for UK rate hikes
The Iran War has triggered an energy shock with oil and gas prices elevated. The extent of the shock is conditional upon how long the conflict lasts and how long energy production and transportation is disrupted. In turn, the prices of fertilisers and other commodities have risen significantly pointing to future higher food and industrial costs.
The longer the war persists, its economic impact is stagflationary: stagnation plus inflation, meaning weaker growth and higher inflation compared with what would have otherwise been the case.
All energy shocks must be judged in the context of the time. Their economic impact has varied. Markets and economists continue to look for lessons from prior energy crises that are relevant for now. The main takeaway is to not generalise.There is currently a tendency to view this war in terms of the two most significant energy shocks, which were 1973-74 and 1979-80. In September 1973 oil was around $2.70 per barrel. Then, the early October Yom Kippur War was the trigger for Arab oil exporters to raise oil prices fourfold by the end of 1973, to close to $12 per barrel, plus a limit to supply. The 1979-80 crisis followed the Iranian Revolution. During 1979 and the first half of 1980 OPEC oil prices rose from around $13 per barrel to $32 per barrel.
There are three takeaways for now. One, the current surge in oil prices, although significant, around 40 percent, does not compare with the rises seen in the 70’s.
Two, is that it took some time for the full economic impact of each crisis to be evident, as the economic contagion spread.
Three, is not to draw the conclusion that is often drawn in the UK, which is that policy must be tightened immediately. Inflation reached 25 percent in 1975 following that crisis. Whereas some other countries, notably Germany avoided the inflation shock. The lesson is not that the UK did not tighten policy. Whereas inflation pressures in the UK were easing ahead of this war, in the early 70’s inflation pressures had already been building before the oil shock. The Barber Boom was already in full swing after the 1972 Budget aimed for 5 percent growth. It achieved 4.5 percent. The money supply grew by 25 percent in 1972 and 27 percent in 1973. Moreover, there had already been an energy crisis for two years in the UK ahead of the October 1973 shock, largely because of industrial action.
The effects of energy shocks differ not only from crisis to crisis, but as we are seeing now, also from country to country.
Western Europe, including the UK, north-east Asia and India are seen as most impacted in economic terms because of their energy dependency. Gas reserves, also, are low in Europe and will be expensive to replenish. Meanwhile the Gulf will benefit once flows resume, although there has been some longer-term damage to production. Also, the policy fall-out will impact all these regions in different ways, including for western economies the need to diversify energy supply and to increase defence spending, thus exacerbating fiscal positions.
While global growth will suffer, its resilience will depend heavily on how the US and China are impacted. Because of its energy self-sufficiency the US is set as relatively better insulated, although the aftermath of tariffs and rapid monetary growth means inflation risks cannot be ruled out. China, meanwhile, is exposed through energy imports from the Gulf but its recent Two Sessions suggests policy levers will be pulled to boost domestic consumption, and although its rapid export growth may be tempered by global events it is still sufficiently strong to support growth. This could, though, feed future trade tensions.
Energy exporters outside of the Gulf, including Russia, Norway, Canada and parts of the US are benefiting from elevated energy prices. It is not just the situation across countries but within them too that is key for policy. In the case of the UK this points to timely, targeted and temporary help for some groups facing higher energy bills, and this may lead to fiscal pressures ahead of the Budget. Over the last year markets have had to adjust to the unpredictability associated with US policy and not just its uncertainty. This war is another, economically damaging reflection of this. Previously the concept of TACO – (President) Trump always chickens out – had seen markets assume policy would adjust if the economic or market consequences were seen as damaging. It is though not possible to retrace fully the geopolitical and economic fall-out from this War. Market attention is focussed on a reopening of the Strait of Hormuz, as the trigger for oil and energy prices to ease.
Even if the Strait were to reopen, the damage to energy facilities across the Gulf may limit the ability of prices to fall to pre-war levels. Of course, if there were a global recession, energy prices could fall sharply. That should not be dismissed, but that demand impact is different to the impact on supply because of this war.
Reports that tankers from certain countries have been allowed to pass through the Strait if they paid the equivalent of $2 million in renminbi to Iran has fed speculation that this may be the prelude to the dollar’s demise as a petrocurrency. This is a valid issue as over the last year the dollar has weakened against the backdrop of policy unpredictability in the US. The dollar’s bounce because of this war may be cyclical and thus short-lived, reflecting that other regions may be hit harder economically. Its status as a safe-haven asset is likely to be questioned further following this war. It may, though, be a slow demise as no other currency can yet challenge it. SWIFT data shows that in February the dollar accounts for 57.5 percent of global payments made outside the eurozone, the euro 14.1 percent and sterling 5.7 percent.
This week the Organisation for Economic Co-operation and Development (OECD) produced an interim economic forecast, and its scenarios provide a useful benchmark. If oil prices were to ease from $107 dollars per barrel in Q2 to $78 per barrel by year end, then global growth would be 0.3 per cent lower this year and 0.1 percent next. Thus, their central case is for global growth of 3.3 percent last year, 2.9 percent this and 3 percent next. If oil prices did not fall, their simulation showed world GDP still falling 0.3 percent in the first year and 0.5 percent in the second, while inflation would rise 0.7 percent and then by 0.9 percent. It reinforces how sensitive the global outlook is to energy prices.
To put this in context, before the global financial crisis, global growth was around 4.5 percent, and in recent years we have viewed global growth of just above 3 percent as the norm, but it is weak compared with the past, and when one allows for the resilience of the US and the growth in emerging economies it only highlights the challenges facing western Europe. Thus, this War has hit western Europe at a time when living standards have largely stagnated for some time.
Central banks with a dual mandate focused on jobs as well as inflation such as the US and China are expected to ease eventually, while central banks with a single mandate to control inflation like the Bank of England are now expected to hike rates.
The UK is seen as being particularly vulnerable to risks of stagflation, given its limited room for policy manoeuvre. Recent years have seen a risk premium factored into UK government borrowing costs because of sticky inflation and fiscal worries. The war has seen gilt yields rise to very high – and what may become attractive – levels as interest rate expectations for this year have shifted from two rate cuts before the war started to three hikes. But at the same time the curve has flattened, suggesting that the market believes the economic hit will prevent inflation from persisting
Importantly, the fact that now it is clear that UK interest rates are not to be cut, is already a significant tightening in itself. The economy will be softer as a result of this war. Raising interest rates now is not a lesson that can be drawn from 1972-73. Instead, it should be to focus on second-round effects before concluding fully whether the inflation impact will pass-through or persist. These second-round effects are what happens to wages, to pricing policy of firms and whether they raise prices to pass on higher costs and maintain or even raise margins. With the Bank of England’s Monetary Policy Committee so divided it is possible that they vote to hike to 4 percent and that may be sufficient to address market concerns. But I think the hurdle for a rate hike needs to be set very high.
This is the opinion of Gerard Lyons on 27 March 2026. This article is for informational purposes only and does not constitute financial advice.