The announcement of a two-week ceasefire in Iran is unambiguously good news for the UK economy. It reduces the risk of a further sharp rise in energy prices, should limit the rise in inflation, will reduce the impetus for rate hikes and reduces the risk of recession. However, another bout of stagflation for the UK still looks unavoidable given the inevitable increase in inflation and hit to demand.
How transformational the ceasefire will be depends on whether it turns out to be a temporary cessation or the start of a permanent end to the conflict. Afterall, the current plan contains clauses that both sides will find difficult to agree to.
Energy prices have fallen back from their recent peaks today but are still well above their pre-crisis levels. But two weeks may not be enough time for many gulf countries to restart shut-in production, and repairs to damaged energy infrastructure will take months or years rather than weeks. That lag may still limit the flow of petrochemicals from the region for the foreseeable future, despite the ceasefire. The key metric to watch is the number of tankers transiting the Strait of Hormuz, a sustained rise in this would signal that energy flows were resuming.
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Even in a best-case scenario it will take months for energy and other supply chains to return to anything resembling normal. At the same time, an elevated risk premium will remain in energy and commodity prices for a long time, reflecting the greater risk that hostilities restart. That is enough to avoid the worst case scenario of shortages and rationing in Europe, which would have caused a recession. But it still means that even though financial markets have rallied today, the economic damage will persist through this year.
For the UK, the ceasefire probably comes too late to avoid another bout of stagflation. First, energy prices at current levels are still enough to push inflation to 3% by the end of the year. And the DMP and PMI surveys both suggest that firms are intending to pass on cost increases. If we add in indirect and second round effects from higher shipping and raw material costs, it is easy to get to inflation of around 3.5%-4.0% by the end of the year.
In addition, the surge in fuel prices has already eaten into consumers disposable incomes and the impact will get worse as higher wholesale prices are reflected in utility bills. At the same time, the sharp shift up in interest rate expectations and mortgage rates will further crimp consumer spending and business investment. The weakness of the labor market will compound the negative impact on spending. Admittedly, the Bank of England can hold fire on interest rate rises if it becomes clear that energy flows are resuming and prices should fall back. But the two to three rate cuts that were priced into markets in February will probably have to wait until 2027 now.
Uncertainty will remain high for the foreseeable future. Consumer confidence and business sentiment has dropped and will remain fragile until there is a more permanent end to the conflict. If consumers delay major purchases and business defer deals and investment, that will be a further hit to demand.
Ultimately, the ceasefire is good news for the UK. If it holds and energy flows gradually resume over the next few weeks, it will significantly reduce the chance of shortages and recession in the UK and Europe.
However, we are far from out of the woods yet. It is unclear whether the ceasefire will hold or result in a permanent deal and, in any case, it will take months for energy supply chains and prices to return to normal, while uncertainty will remain high. The result is still another bout of stagflation for the UK, although it may look more like stagflation-lite if energy prices continue to drop.”
