There is a threat of high inflation coming to the UK but only from the conflict in the Middle East, which could keep oil prices high for much longer than was expected when Donald Trump first began attacking Iran.
It is the war that makes the difference between a benign outlook for inflation and one that puts it back on a rising trajectory, senior UK central bankers believe.
The Bank of England’s monetary policy committee was clear in its decision on Thursday to hold interest rates at 3.75% that underlying pressures on inflation are almost entirely absent in the domestic economy. Prices are stable and, without the war, would be rising steadily at the central bank’s 2% target.
Threadneedle Street officials are worried that retail prices will ratchet up if companies spot a way to increase them, taking advantage of a general expectation among consumers that the war has raised the costs of production. They also fear that workers will see another rise in inflation coming and pitch for a major increase in wages.
They haven’t seen any of these trends yet. If anything, the opposite is true and the spillover, or second-round effects from rising energy and transport costs, remain muted.
Supermarkets have proved resilient and kept food inflation low. Services companies – for so long after the pandemic a source of rising prices – have managed to restrict increases this year.
As the Bank’s quarterly review says: “So far, there are few signs of second-round effects. But there is not enough evidence yet to rule out this risk, and the MPC will continue to monitor 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 wage increases at a level Bank officials are comfortable with.
As for companies capitalising on a period of rising prices whether or not it actually affects them, the official data does not show that happening across the manufacturing, construction or services industries.
The three MPC members who voted to increase the cost of borrowing this month acknowledge that neither workers nor firms have reacted to inflation. They argue that the figures we have seen – the latest being the drop in the consumer prices index (CPI) to 2.6% in June – are a reflection of cost pressures, or more precisely the lack of them, going into the conflict. Once prices begin to rise again, workers and companies are bound to react, they argue, embedding inflationary pressures into the UK economy even if the Middle East war is settled.
The majority on the MPC focused more on the labour market and a rise in unemployment and sharp fall in vacancies over the last three years. They also see that financial markets have reacted by raising mortgage and commercial lending rates, tightening the screw on homebuyers and firms without the Bank making a move itself.
If anything, businesses that want to invest and with that employ more people could do with a boost from lower interest rates.
It is only Donald Trump’s failure to confect an exit from the Middle East crisis that stands in the way of that.
The Bank’s 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 go back above $100 a barrel and stay there.
The National Institute of Economic and Social Research said this week that the UK had already lost the equivalent of £28bn in growth this year as a result of the Middle East conflict.
The Bank’s warning that it might need to raise rates if the war continues means the impact on businesses, consumers and mortgage borrowers could, unless Trump pulls back, be much more severe.
