WeekWatch

Central banks turn hawkish on Iran conflict 

With the Iran conflict approaching the one-month mark, global markets are struggling to keep up with fast moving developments in the region. 

This morning, equity markets rose notably as Trump announced a five day pause to strikes on the back of successful talks. This immediately sent equities up, while oil prices and gilt yields moved in the other direction.

Before this, the opposite had been happening as the two sides traded escalatory statements with one another. Over the weekend Trump gave Iran a 48-hour ultimatum to fully reopen the Strait of Hormuz or face attacks on its energy infrastructure. Iran responded by threatening like-for-like retaliation on US-linked assets in the region.

When markets are moving fast and reacting to breaking developments, prices can change quickly. For example, shortly after the Trump announcement, Iran denied talks had taken place. It is important to not make short-term, emotional investment decisions, or to try and ‘time the market.’ It is currently impossible to know the direction of travel over the next few days, let alone weeks. 

The fog of war

Ultimately, the more medium-to-long term effects of the Iran conflict remain shrouded in the fog of war.

For example, following a string of strikes on gas and oil facilities across the Middle East last week, we know that global energy production will remain curtailed for some time, even if a lasting peace was agreed tomorrow. 

This will translate into elevated prices and, with it, rising inflation in the coming months. However, the scale and length of this are still unclear.

How this will affect global markets is also uncertain. When Russia invaded Ukraine in 2022, equity markets fell but then bounced back. Prior to the US/Israeli attack, markets were trading at or near record highs globally. Will they recover quickly this time too?

Four years ago, governments stepped in to support consumers with energy prices, limiting some of the inflationary effects. However, if oil and gas prices keep rising, there are questions as to what steps the government would want or be able to take this time. 

The world is in a different place compared to then. The Ukraine war was on the back of the Covid pandemic. Consumers came out of that with excess savings they could spend, powering a recovery. Inflation was already climbing rapidly, while interest rates were still extremely low. This time consumer savings are lower, interest rates are higher and both these and inflation were on a generally downward path. In other words, equity markets may not follow a similar path to that seen four years ago.

Central bank reactions

The current situation is also putting central banks in an awkward position. Given the rising energy prices and uncertainty, it was unsurprising that the Bank of England (BoE) voted to keep rates the same when it met last Thursday. 

The BoE specifically noted that CPI inflation was now expected to be close to 3.5% in March. This is almost 0.5 percentage points higher than predicted in February due to the higher energy prices. It said it stood ‘ready to act as necessary’ to ensure that CPI inflation remains on track to meet its 2% inflation target.

Before the conflict, markets had priced in two interest rate cuts over the year. Now, it is expected to increase rates two or three times over the year – a significant swing.

As investors bet on more rises, gilt yields have risen. On Friday, they hit their highest levels since 2008, with the benchmark 10-year rate crossing 5%. Following Trump’s ceasefire announcement, yields fell to below 4.9%. Higher borrowing costs will impact government’s fiscal headroom in the future.

While this was the most dramatic swing, it wasn’t the only central bank to make an interest rate decision. Over the past seven days, the US Federal Reserve, European Central Bank and Bank of Japan also all voted to keep interest rates as they were. 

Hetal Mehta, Chief Economist at St. James's Place, noted: "This week saw an unusually heavy central bank calendar, with the Fed, BoE, ECB and BoJ all in the same week for the first time since December 2021. Back then, in a pre-Russia-Ukraine conflict era, the global economy was still emerging from the pandemic. Growth was solid, inflation was picking up rapidly and interest rates were still very low. Then came the Russia-Ukraine conflict which saw energy prices soar, triggering the first major supply shock since the 1970s. Central banks tore up the textbook prescription to look through supply shocks and hiked rates aggressively in the hope of containing inflation expectations.

"Fast forward to the current juncture, and the same central banks are once again grappling with another energy shock, this time stemming from the disruption in the Middle East. All four of the central banks voted to keep interest rates unchanged amid a fast-moving and very uncertain backdrop, highlighting the intention to wait and see.”

Households told to brace for higher costs as Iran conflict deepens

Consumers are starting to feel the inflationary effects of the conflict in the Middle East. It comes as it approaches the one-month mark since the US began its attack on Iran.

The disruption in the Strait of Hormuz, the narrow shipping route on Iran’s southern coast, has led to a dramatic drop in shipments of oil and gas. This has pushed up the cost of energy, with UK drivers now seeing prices rise at petrol pumps.

Households are being warned to brace for much higher domestic energy bills in the coming months. The cost of food and consumer goods, such as clothing and electronics, are also likely to rise due to the increased cost of transport and higher bills along the supply chain.

As inflation inches higher, banks are taking a more cautious approach to lending. Lenders across the market have been nudging up the cost of fixed rate mortgage deals in recent weeks. This will mean higher borrowing costs for first-time buyers and remortgage customers.

The Iran conflict is also likely to create longer-term increases to consumer costs. It could become more expensive to go on holiday as airlines face higher fuel bills. Some types of insurance, such as motor and home, may increase as insurers face higher costs to settle claims. These costs will then be passed on through higher premiums.

Tips for UK consumers to minimise the impact of costs:

• Switch cash savings to more competitive accounts with higher interest rates.
• Review the fixed-rate energy tariffs available and consider switching.
• Look into building long-term financial resilience by investing in ISAs and pensions.
• Speak to a financial adviser about any concerns to help ensure financial plans remain on track.

Government to impose 10-year backstop on FOS complaints

HM Treasury has confirmed it will impose a 10-year absolute limit for complaints submitted to the Financial Ombudsman Service (FOS).

Currently there is no time limit where consumers have only just become aware of a problem or detriment.

Under the proposed reform, the 10-year limit will remain absolute, but the Financial Conduct Authority will retain discretion to grant limited exceptions where appropriate.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. 

The favourable tax treatment of ISAs may be subject to changes in legislation in the future.