Reeves is determined that the UK economy is on the right track: but will the Iran conflict derail it?
- The oil price gone from under $50 a barrel at the end of December, to $83
- UK natural gas prices rose from 76p to 133p in recent trading
- Interest rate cuts could be at risk if energy price rises persist
Chancellor Rachel Reeves delivered her Spring Statement with a dose of punchy optimism: inflation was down, she said, along with interest rates; borrowing had dropped, and living standards were rising. While her critics did not always share her analysis, at least she believes the economy is turning a corner. However, might this benign picture be destroyed by the war in Iran?
The worry is energy prices. The oil price has gone from under $50 a barrel at the end of December, to its current level of around $83. This is roughly where it was at the start of 2025. It is worth noting that it had been above its current level from 2022 to 2025. Natural gas prices are also a concern: UK natural gas prices rose from 76p to 133p (per therm) in recent trading. Again, this is nowhere near their level during the early phase of the Ukraine crisis when they spiked to 655p, but it puts them closer to the level seen at the start of 2025.
If this pushes inflation higher, it could derail plans to cut interest rates. In a note this week, the National Institute of Economic and Social Research (Niesr) said the Bank of England will have to contend with a “shock” to energy costs which could “cause problems for Rachel Reeves”. It said there were two scenarios: one, if the price spike is temporary, and the second if it lasts more than a year.
If energy prices begin to normalise after three months, it could have an impact of around 0.3 percentage points on the Consumer Prices Index (CPI) inflation for 2026 relative to previous forecasts from its February economic outlook. In this case, the Bank of England is likely to look past it and continue on its current path.
If energy price rises persist for a year before steadying, it could push up CPI inflation by 0.7 percentage points in 2026, and by 0.5 percentage points in 2027. In this case, the Bank could be forced to raise rates back up above 4%.
This, in turn, is likely to weigh on government forecasts. The gilt market has been well-behaved in recent weeks, with the 10-year yield dropping from around 4.6% to lows of 4.2%. This has given Reeves plenty of flexibility. However, it has started to edge higher in recent days, and is now sitting at 4.38%.
Oliver Faizallah, head of fixed income research at Charles Stanley, says this could be a longer-term problem: “A key driver of the sell-off in government bonds comes amidst fears of rising oil prices, which will likely have a knock-on effect on broader inflation, minimising the ability of central banks to cut rates. In addition, fragile fiscal positions are brought back into the spotlight as markets see potential for an increase in defence spending should the conflict persist.”
The conflict could dent the Chancellor’s optimism that the UK economy is reviving. However, it is far too soon to draw that conclusion. Energy prices have already started to reverse. There is also the potential for Trump to back away: he will not want to go into the midterms with energy prices at their current levels.
