Key Takeaways:
Bank of England Governor Andrew Bailey said the fresh exchange of fire between the US and Iran shows an "unstable" Middle East conflict, but the passthrough of higher energy prices into UK consumer prices has remained contained so far.
"We are seeing continued fairly soft evidence on the passthrough into UK prices," Bailey told lawmakers Tuesday. The latest outbreak of violence "underlines that this is going to be an unstable process for the foreseeable future," he said.
The US launched its third consecutive night of strikes on Iran Monday, targeting a submarine and ship maintenance facility in response to Iranian attacks on commercial vessels in the Strait of Hormuz. Brent crude jumped more than 4% on the escalation, though prices remain below peaks reached earlier in the conflict. Vessel activity through the strait declined about 52% over July 10 to 12 compared with the prior week, according to MarineTraffic data.
The UK's annual inflation rate stood at 2.8% in May, above the BOE's 2% target but below levels recorded before the conflict erupted in February. If energy prices sustain their recent gains, the central bank may face a more difficult trade-off between supporting growth and containing prices at its next policy meeting.
Oil Prices and the Inflation Passthrough
Bailey's comments come as oil markets price in a sustained risk premium for crude transiting the Middle East. President Donald Trump said Monday the US was reinstating a blockade of Iranian shipping in the Gulf and would ensure the Strait of Hormuz stays open — for a 20% fee on all cargo shipped. Iran's Revolutionary Guards said they continued to control the channel and that the only way to restore regular shipping was to end US military interventions in the waterway.
The BOE's data-dependent approach means the central bank is watching energy costs closely. Before the conflict, around a fifth of the world's oil and gas traffic passed through Hormuz daily, delivering more than 15 million barrels per day of fuel to global markets worth at least $1.2 billion. A sustained disruption could push inflation higher, though Bailey indicated the evidence so far does not warrant a policy response.
The UN's shipping agency pushed back against Trump's proposed fee, saying there is no legal basis for introducing mandatory tolls on strait transits. Iran has separately sought to establish its own permit system for vessels using the waterway, complicating the outlook for shipping costs and, by extension, global energy prices.
Market Reaction and Forward Outlook
The pound slipped against the commodity-linked Canadian dollar as oil prices rose, with GBP/CAD trading at CA$1.8931, down 0.2% on the day. Sterling was able to avoid steeper losses as political optimism in the UK continued to support the currency. The euro also edged lower against the loonie, with EUR/CAD at 1.6115, while USD/CAD traded at 1.4136.
The BOE's next policy decision will be closely watched for any shift in tone on inflation risks. With the annual rate at 2.8% and geopolitical uncertainty persisting, Bailey's cautious stance suggests the central bank is in wait-and-see mode, balancing the risk of resurgent inflation against the drag from global instability. The conflict, now in its fifth month, has already killed thousands of people, mainly in Iran and Lebanon, and shows no signs of de-escalation.
Bailey's comments may temper expectations of aggressive BOE tightening in the near term, supporting UK gilts and risk assets. However, the ongoing instability keeps energy price risk elevated, which could pressure bonds and increase volatility in sterling and UK equities if the situation deteriorates further. The central bank's next move will depend on whether the current oil price spike proves temporary or becomes entrenched in broader inflation measures.
This article is for informational purposes only and does not constitute investment advice.
