UK markets faced renewed selling pressure this week, with the FTSE 100 Index falling 1.48% to trade at 10,090 points at the time of writing.
The Bank of England has warned that a prolonged energy shock from the Middle East war will drive up inflation, opening the door to higher interest rates and deepening a brutal sell-off in the gilt market. In a sign of how radically the war has reshaped the challenge facing rate-setters, the Monetary Policy Committee said that a severe energy shock could feed into wages and prices across the economy.
The committee voted unanimously to hold interest rates at 3.75% at its first meeting since the US and Israel attacked Iran last month, triggering a surge in global energy prices. The decision came hours after a wave of attacks on energy facilities in Iran and across the Gulf sent oil and gas prices sharply higher, with Brent crude briefly touching $119 a barrel.
Investors have increased their bets on interest rate hikes this year, with markets now pricing in at least two 0.25% rises and a small chance of a third. Bank of England Governor, Andrew Bailey stressed that the appropriate thing was to hold rates at this point, but cautioned against reaching any strong conclusions about rate rises given the uncertain environment.
He also drew attention to a recent softening of the labour market and economic conditions, stressing that the current energy shock is occurring in a very different context to the one in 2022 following Russia’s invasion of Ukraine. “There is somewhat of a weakening in demand and interest rates are higher, so these things come into the picture” Bailey said.
Before the war started, investors had expected the Monetary Policy Committee to cut rates at its March meeting, with policymakers having forecast that inflation would return to its 2% target in the second quarter. The energy shock has raised the stakes for the Monetary Policy Committee, which must now balance the renewed risk of inflation with lacklustre economic growth.
The Bank of England was previously expecting UK inflation to subside to 2.1% in the second quarter, but it now predicts consumer price inflation growth of 3%. Inflation could accelerate to 3.5% in the third quarter, well above its 2% target, the central bank added.
UK unemployment remained at a post-pandemic peak of 5.2% between November to January, but lower than the 5.3% analysts had expected. Payroll employment rose by 6,000 between December and January, the Office for National Statistics said, and provisional figures pointed to a further gain of 20,000 or 0.1% between January and February, as uncertainty over fiscal policy eased following November’s budget.
Commodity markets
In the commodity markets, Brent crude futures traded around $107 per barrel on Friday, rising again this week, as the Iran conflict continues to drive a sharp rally across oil and related commodities.
Oil prices lost some momentum towards the end of the week after US Treasury Secretary Scott Bessent said Washington may soon lift sanctions on Iranian crude stored aboard tankers, a move aimed at easing price pressures following Iran’s closure of the Strait of Hormuz. Israeli Prime Minister Benjamin Netanuahu also told reporters that Israel is assisting US efforts to reopen the Strait of Hormuz, according to wire reports and that Israel would refrain from further attacks on Iranian energy infrastructure.
He added that Iran no longer has the capability to enrich uranium or produce ballistic missiles, adding that the war could end sooner than many expect. Leaders from the UK, France, Germany, Italy, the Netherlands, Japan and Canada have also signalled their willingness to support efforts to ensure safe passage through the Strait of Hormuz.
Gold prices traded around $4,680 an ounce on Friday and are headed for a third consecutive weekly decline, pressured by a firm US dollar and as a hawkish US Federal Reserve dampened hopes for near-term interest rate cuts.
Equity markets
US equity futures rose on Friday, following efforts by the US and Israel to calm market fears over the Iran conflict. US President Donald Trump said that the US is not considering sending ground troops to the Middle East, while Treasury Secretary Scott Bessent suggested Iran’s regime could face internal collapse.
In Thursday’s regular trading session, the Dow Jones Industrial Average fell 0.44%, the S&P 500 lost 0.27%, whilst the Nasdaq Composite declined 0.28%. Federal Reserve Chair Jay Powell has acknowledged that the Iran war will raise inflation as a fresh jump in oil prices sent short-term US borrowing costs to the highest level since last summer.
The US central bank left interest rates on hold at 3.5% to 3.75% for the second meeting in a row, as policymakers balance concerns that the Middle East conflict will ignite a fresh burst of consumer price rises against a weakening labour market. A new set of economic forecasts showed that Federal Reserve officials are now expecting the central bank’s preferred Personal Consumption Expenditures inflation rate will end the year at 2.7%, above the 2.4% they predicted in December and well above the 2% target.
Trading in federal funds futures suggests that investors are anticipating the next Federal Reserve rate cut in July 2027, marking a stark change from before the Iran war began, when market had been pencilling in as many as two cuts. The shifts in Wall Street’s monetary policy expectations come as petrol and diesel prices have leapt higher in recent weeks, exerting a heavy toll on consumers and businesses in a country that relies heavily on driving for travel and transporting goods.
Projections released on Wednesday showed that Federal Reserve officials still plan to cut rates by 0.25% this year, in line with their previous set of forecasts in December. Twelve of the 19 members of the Federal Open Market Committee predicted at least one cut, against seven who said rates would remain the same. However, Powell signalled not to read too much into the Fed’s current forecasts given the high degree of uncertainty over the Iran war.
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