Fed and Bank of England weigh rate rises as oil prices surge

The European Central Bank has raised interest rates to 2.5%, and the US Federal Reserve and the Bank of England will make their own rate decisions within days. Brent crude is trading near $105 a barrel as the US-Iran war restricts shipments through the Strait of Hormuz, pushing energy and transport costs higher.

What did the European Central Bank do?

The ECB raised rates to 2.5%, citing the Middle East conflict and warning that inflation was “set to remain well above” its 2% target for some time.

What will the US Federal Reserve decide?

The Fed announces its decision on Wednesday. It has held rates between 3.5% and 3.75% for five meetings in a row, and its last change was a cut in December. A strong jobs market and President Donald Trump’s remark that he does not expect oil prices to fall until the Iran war ends, which he expects after November’s elections, have led many on Wall Street to bet on a hike this month.

Newly appointed Fed Chair Kevin Warsh has stayed tight-lipped on his view of rates, but his repeated comments that the central bank should focus on slowing price rises have fuelled those expectations. Deutsche Bank economists called a rate hike “the most likely policy outcome”. Grace Zwemmer, US economist at Oxford Economics, expects rates to remain unchanged, but a cut appears off the table almost universally.

Trump has again pressed for lower rates, posting on social media last week: “The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change.”

Why are oil and gas prices pushing inflation up?

Shipments through the Strait of Hormuz, one of the world’s busiest oil and gas routes, have been restricted by the US-Iran war. A barrel of Brent crude is now around $105 (£78), approaching levels last seen at the outbreak of the conflict. Higher energy prices raise costs for households and businesses directly and also make transporting goods more expensive, with those costs passed to consumers through steeper prices for food and other staples.

Central banks try to contain price rises by raising interest rates, which increase the cost of borrowing on mortgages and credit cards, slow consumer spending and give people an incentive to save rather than spend. Higher rates can also discourage businesses from investing and hiring.

What is the Bank of England expected to do?

The Bank of England meets later next week and is expected to leave rates at 3.75%. Millions of UK households face energy bills rising to the highest level in three years heading into the winter, and gas prices have risen above 200p per therm for the first time since the end of 2022. UK inflation stands at 2.9% and is expected to jump in coming months.

How does this inflation shock differ from 2022?

Oxford Economics sees “no sign” of second-round effects feeding through the economy, such as workers requesting wage rises or businesses hiking prices, which economist Alexander Harvey said gives the Bank “some breathing space”. Yael Selfin, chief economist at KPMG, said that outside the US the economic environment in places such as the UK is “much weaker” than in 2022, when the last inflation shock hit and UK inflation reached a record high of 11.1% in October that year.

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 after 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.” Hiring is now weaker than average and there is less pressure to recruit, giving employees less leverage to demand higher pay.

Frequently asked questions

What interest rate did the European Central Bank set?

The European Central Bank raised rates to 2.5%, citing the Middle East conflict and warning that inflation was set to remain well above its 2% target for some time.

When does the US Federal Reserve decide on interest rates?

The Fed announces its decision on Wednesday, after holding rates between 3.5% and 3.75% for five meetings in a row. Its last change was a rate cut in December.

What is the Bank of England expected to do with interest rates?

The Bank of England meets later next week and is expected to leave rates at 3.75%, with UK inflation at 2.9% and energy bills set to reach a three-year high.

Why is Brent crude trading around $105 a barrel?

Shipments through the Strait of Hormuz, one of the world’s busiest oil and gas routes, have been restricted by the US-Iran war, pushing a barrel of Brent crude to around $105 (£78).

With reporting from BBC News.

Stock image, not from the events described. Closure of Morrisons petrol station, Wetherby during the 2021 United Kingdom fuel crisis (26th September 2021) 002 — Mtaylor848 / Wikimedia Commons (CC BY-SA 4.0)