Bond Markets Reel and Rate Cut Hopes Die as Oil Crisis Fuels Inflation Fears

Central bank rate-setters around the world are facing a dramatically altered landscape after oil prices surged past $90 a barrel this week, driven by the Iran conflict and a worsening Middle East energy crisis. In the UK, the probability of an interest rate cut this month fell from 80% to just 15% in the space of days, as the prospect of energy-driven inflation made a rate reduction politically and economically untenable.
The bond market reaction was equally dramatic. Yields on UK five- and ten-year government bonds recorded their biggest weekly jump since the Liz Truss mini-budget of September 2022 — a reference point that carries particularly painful associations for British financial markets. Eurozone bond yields also surged, with the weekly rise being the largest since March of last year. Money markets are now pricing in the possibility of a rate rise from the European Central Bank by year’s end.
The oil price surge at the heart of these market moves was triggered by the Iran conflict and amplified by Kuwait’s decision to cut production at fields running short of storage space. Brent crude reached $91.89 a barrel on Friday — up more than 25% from pre-war levels — its biggest weekly percentage gain since the early weeks of the Covid-19 pandemic. Energy consultants have warned that storage constraints in Saudi Arabia and the UAE could force further production cuts within 20 days.
The inflationary implications of these moves are significant. Oil is an input into virtually every sector of the economy, from transportation and manufacturing to food production and retail. When crude prices rise 25% in a week, the downstream effects on consumer prices can take months to fully materialise — meaning the inflationary impact of this week’s surge may not be fully felt until later in the year. Central banks, which had been cautiously optimistic about the inflation outlook, are now facing an unwelcome reassessment.
Stock markets added to the week’s misery. Asian indices suffered their worst performance since the Covid-19 pandemic, while UK and European stocks fell more than 5%. Airlines, among the most fuel-sensitive sectors, were the biggest losers. Gold, surprisingly, fell about 3.5% during the week, suggesting that investors were moving to cash rather than precious metals as their preferred safe haven.