Deutsche Bank: Middle East energy shock could derail the Bank of England's anti-inflation process

Investing.com — As the US-Iran conflict escalates, triggering a surge in energy prices, the Bank of England (BoE) is facing a new round of inflation threats, which could derail the UK’s anti-inflation process. According to latest analysis from Deutsche Bank (NYSE:DB), the “oil shock” caused by the actual closure of the Strait of Hormuz could push the UK’s overall inflation rate back to around 3% by the end of 2026.

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The FTSE 100 index continued to come under pressure on Monday, falling 0.85%, as investors weigh the impact of rising costs. Analysts note that although the UK was on track to reach the BoE’s 2% target, the sudden surge in Brent crude oil prices to around $95 per barrel has introduced a significant “inflationary push.” The BoE’s Monetary Policy Committee (MPC) now faces a complex situation, needing to balance slowing economic growth with input cost-driven inflation.

Energy Transmission Effects and the 3% Inflation Risk

The main concern at Threadneedle Street (the BoE’s location) is the speed at which wholesale energy prices are transmitted to the Consumer Price Index (CPI). Deutsche Bank’s models show that a sustained 10% increase in oil prices typically adds about 0.2 to 0.3 percentage points to the UK’s overall inflation within 6 to 12 months.

The Strait of Hormuz accounts for a large portion of global liquefied natural gas and oil transportation. Any prolonged disruption could lead to soaring utility bills and transportation costs domestically.

Unlike the 2022 gas-driven crisis, the latest shock centers on crude oil and maritime logistics. UK “commodity” inflation is expected to be hit particularly hard, potentially offsetting recent cooling in the services sector. Strategists emphasize that if oil prices remain above $100, the BoE may be forced to abandon its planned easing cycle to prevent a second-round effect in wage negotiations.

Monetary Policy Committee Policy Path: Longer Duration of High Interest Rates?

Geopolitical shocks have significantly altered market expectations for the BoE’s benchmark interest rate. The swap market is now pricing in a higher likelihood that the BoE will keep restrictive rates until 2027. This “stagflationary” shock — where prices rise while output weakens — poses a direct threat to UK GDP. Deutsche Bank estimates that if energy costs stay high, UK GDP could be weakened by 0.4% in 2026.

The GBP/USD currency pair has shown resilience, supported by a more hawkish outlook from the BoE. However, analysts warn that if energy shocks lead to a deeper contraction in industrial production, the pound’s strength may be short-lived.

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