UBS interprets the Bank of England's interest rate decision this week

Investing.com - UBS economist Dean Turner stated that the Bank of England is expected to keep interest rates unchanged at 3.75% at this week’s meeting, as policymakers assess the ongoing conflict in Iran and its impact on the economy.

On the occasion of this meeting, the U.S. conducted a new round of strikes on Iranian military facilities, including Hark Island. Hark Island’s energy facilities handle about 90% of Iran’s crude oil exports but were not affected by the strikes.

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As hopes for a quick resolution to the conflict fade, energy markets remain volatile. Gasoline and diesel prices have already started to rise, and the cost of aviation fuel is also climbing. UBS estimates that a sustained increase of £10 per barrel in oil prices could raise overall inflation by 0.3% to 0.5%.

Since the conflict began, wholesale natural gas prices have risen by about 70%. While UK households are currently protected by price caps, if wholesale prices remain high, charges will increase.

Despite these pressures, UBS believes the current economic situation differs significantly from when Russia invaded Ukraine in 2022. At that time, overall inflation exceeded 5%, and the Bank of England had already started raising interest rates, becoming the first major central bank to do so in December 2021.

Inflation has been declining over the past few months, and before the Iran conflict erupted, inflation was heading toward the Bank of England’s 2% target. There is evidence that the labor market is softening, and January’s GDP growth data was disappointing.

The current 3.75% rate is considered restrictive, above UBS’s estimated neutral range of 3% to 3.25%. This contrasts sharply with the 0.25% rate when Russia invaded Ukraine.

UBS expects policymakers to shift from the recent “cautious and gradual” language to emphasize “remaining vigilant” at this week’s meeting. The baseline scenario assumes the conflict will be relatively short-lived, allowing energy prices to fall in the coming weeks as fuel flows through the Strait of Hormuz resumes. In this case, UBS expects the Bank of England to start cutting rates as early as April.

If the conflict persists, the benchmark rate may remain at 3.75%, with policymakers assessing this as a temporary inflation shock.

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