There’s nothing like talk of energy prices and potential higher borrowing costs to remind us that the summer holidays are well and truly over. Surging oil prices have been pushing up what drivers pay at the fuel pumps and eating away at household budgets for months, and concerns remain over whether the economic impact of the US-Iran war will drive the cost of living higher. Citing the Middle East conflict and warning inflation was “set to remain well above” its 2% target for some time, the European Central Bank recently raised interest rates to to 2.5%, Other central banks are also responding, with the US and the UK poised to make interest-rate decisions next week. Up first on Wednesday is the US Federal Reserve, which has held rates steady between 3.5% and 3.75% for five meetings in a row.
It last made a change – a rate cut – in December. But a strong job market and President Donald Trump saying he does not think oil prices will come down until the Iran war ends, which he expects to happen after November’s elections, has led many on Wall Street to bet on a rate hike this month. Newly-appointed Fed Chair Kevin Warsh has remained tight-lipped on where he sees interest rates going, but his repeated comments that the central bank’s focus should be on slowing price rises has further fuelled expectations of an increase. Economists at Deutsche Bank said recently that a rate hike is “the most likely policy outcome”, noting comments from Warsh and other members of the Fed.
Views differ somewhat, with Grace Zwemmer, US economist at Oxford Economics, expecting rates to remain unchanged, but almost universally a rate cut appears to be off the table. Trump, though, is again pressing for lower rates. “The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change,” he posted on social media last week. Oil, gas and borrowing costs surge as fears over Middle East escalate Fed has ‘work to do’ if price rises don’t ease for Americans, Warsh says Borrowers expecting mortgage rates to drop have hopes dashed The US-Iran war and resulting higher global oil and gas prices are stoking the inflation fears.
Shipments through the Strait of Hormuz waterway, one of the world’s busiest oil and gas routes, have been restricted due to the war and a barrel of Brent crude is now around $105 (£78), approaching levels last seen at the outbreak of the conflict. Along with directly driving up costs for homes and businesses, higher energy prices can also make transporting goods more expensive and that can be passed down to consumers through steeper prices for the likes of food and other staples. Central banks try to limit price rises with higher interest rates. By pushing up the cost of borrowing for things such as mortgages and credit cards, they seek to slow consumer spending and inflation.
Higher rates also can give people incentives to save instead of spend. But its a balancing act, as higher rates can also encourage businesses to hold off on investing and hiring. When the Bank of England meets later next week, it is expected to try to look both at current price pressures and the wider economic picture. Millions of UK households are set to see energy bills rise to the highest level for three years heading into the winter and gas prices have risen above 200p per therm for the first time since the end of 2022.
Inflation in the UK is at 2.9%, and it is expected to jump in coming months. But despite those predictions, there appears to be broad agreement that the Bank will leave rates at 3.75%. That’s because there is “no sign” of the so-called second-round effects of the price shock feeding through the economy, such as workers requesting wage rises or businesses hiking prices, according to Oxford Economics. This gives the Bank “some breathing space”, added economist Alexander Harvey.
Yael Selfin, chief economist at KPMG, said that outside of the US, in places such as the UK, the economic environment has been “much weaker” than where it was in 2022, when the last inflation shock hit the world. UK inflation reached a record high of 11.1% in October that year. Interest rates are already higher than four years ago, she added, and consumers, somewhat scarred by previous price hikes, have changed how they spend. Also, four years ago “businesses were hiring aggressively, vacancies were at record highs, and more people were moving jobs than normal”, Harvey said, as the economy rebooted following Covid.
“The conditions were in place for employees to push for significant pay rises in response to a significant inflation shock,” he said. “That’s in stark contrast to the current labour market.” Now, hiring is much weaker than average and there is less pressure to recruit – giving employees less leverage to demand higher pay. Borrowers expecting mortgage rates to drop have hopes dashed
