The soaring oil prices may push the UK inflation rate back to the high level of 5%. The dream of a rate cut by the central bank this year may be shattered.

The conflict in the Middle East has caused a rise in oil and gas prices, posing a significant inflation risk to the UK. According to estimates released on Monday by the Dutch international group (ING) and RSM UK, if the recent increase in oil and gas prices is sustained, the UK inflation rate could rise to more than double the Bank of England's 2% target. Brent crude oil broke through $100 per barrel for the first time since 2022. James Smith, an economist at the Dutch international group, stated that if oil prices continue to rise in the second quarter, the inflation rate could reach 4.7% by September. RSM UK economist Tom Pew estimated that this could lead to inflation rates between 4.5% and 5%. Since the summer of 2024, the Bank of England's monetary policy committee has gradually reduced interest rates from a peak of 5.25% to 3.75% as the inflation threat eased. However, the drastic fluctuations in the energy market on Monday also led to significant changes in market expectations for the Bank of England's policy. With the prospect of UK inflation rates rebounding to as high as 5%, traders are increasing bets on a possible reversal of recent interest rate cuts. Three weeks ago, before the US and Israel launched attacks on Iran, the market expected the Bank of England to cut interest rates twice by 25 basis points each this year, bringing rates down to 3.25%. The probability of a rate cut at the policy meeting on March 19 was 80%. Before the outbreak of conflict in the Middle East, the Bank of England expected the inflation rate to fall to its target level of 2% in the spring. Now the market expects that the Bank of England will not cut interest rates this year, with some even previously factoring in a 60% probability of an interest rate hike. In this situation, the UK mortgage market has already been affected, with the average rate for a two-year fixed-rate mortgage rising from 4.82% to 4.87% in less than a week. In addition to the Bank of England, the significant increase in inflation will also pose a major challenge to the UK Labour government, which has repeatedly promised to address the issue of living costs. Following discussions among G7 finance ministers on Monday about increasing oil supplies to ease the situation, UK Chancellor Rives stated that she would support a plan to "coordinate the release of collective oil reserves". Prime Minister Stamer stated on Monday that the UK is capable of addressing this global shock. Despite economists raising forecasts, Stamer emphasized that recent inflation has already decreased and stated that the Labour party has "done a lot of work over the past 18 months to strengthen the economy's resilience". However, some economists believe that the impact of the energy shock on the UK is relatively small. Bloomberg Economics UK economists Dan Hansen and Anna Andrade stated that if oil prices remain at $100 per barrel, natural gas prices remain at 1.50 per therm, and then fall back to $80 per barrel as expected by the market, UK inflation will be "slightly below 3%" by the end of the year. Nevertheless, this is still about 1 percentage point higher than the Bank of England's latest forecast. Rob Wood, chief UK economist at Temple of the Ten Gods macroeconomics, provided a more conservative estimate. He expects UK inflation rates to fall in the coming months, not reaching the Bank of England's expected 2%, and then rise to over 3% in the second half of the year. Dan Hansen and Anna Andrade wrote, "We believe that in the face of such a magnitude of shock, the Bank of England's response this year may be to keep interest rates unchanged - the weak labor market means that the threshold for tightening policy is quite high". James Smith also pointed out that the weak labor market may limit the second round of inflation effects, which had kept inflation high after the 2022 Russia-Ukraine conflict-induced energy shock. He stated, "Given that the UK's household energy price cap is determined based on a three-month average of wholesale prices, the duration of high prices may be more important than the peak amplitude". After being criticized for moving too slowly in response to the price pressures caused by the Russia-Ukraine conflict - when inflation rose to over 11% at one point and the tense labor market made it difficult to suppress price growth, Bank of England officials may be more cautious about any energy shock. Martin Weill, a former Bank of England rate setter and current economics professor at King's College London, previously stated that the Monetary Policy Committee is "likely to be highly vigilant about ignoring energy price increases after the last round of soaring energy prices". Energy price increases leading to inflation can push up prices while suppressing economic growth. Weill stated that the Bank of England cannot offset this economic shock but can try to prevent a wage-price spiral. He hinted that he would not support rate cuts and stated, "If I were still on the Monetary Policy Committee, I would be concerned about stimulating demand at the current level of inflation".