If you have not found yourself exclaiming in disbelief at the cost of petrol recently, you are likely in the minority. Fuel prices are reaching unprecedented heights, but they are not alone. Energy bills and mortgage rates are also climbing sharply, creating a perfect storm of financial pressure for households across the nation. Understanding the root causes can feel overwhelming, especially against a backdrop of global conflict and personal economic strain.
The Root Cause: External Economic Shocks
To shed light on this complex situation, we consulted Dr. Danilo Spinola, a senior lecturer in economics at Birmingham City University. He identifies the primary driver as what economists term "external shocks." These are events outside the domestic economy that disrupt normal functioning.
"The war involving Iran has created a significant issue regarding global energy choke points," explains Dr. Spinola. "Approximately twenty percent of the world's oil and fertilisers transit through the Strait of Hormuz. Its closure due to the conflict has led to a substantial reduction in global oil supply."
This supply shock has dramatically increased oil prices. As oil is a fundamental energy source and a key component in fertiliser production, the ripple effects are extensive.
The Domino Effect on Broader Inflation
"This creates a shock that permeates other sectors of production," Dr. Spinola continues. "The rise in oil prices consequently impacts food prices, gas prices, transportation, and shipping costs. This, in turn, affects the price of everyday goods, generating widespread inflation across the economy."
This broad inflation is precisely what triggers concerns with mortgages and other financial instruments. As prices rise or are expected to rise, central banks, like the Bank of England, intervene.
"Increasing interest rates is the primary tool the central bank employs to combat inflation," says Dr. Spinola. "By raising rates, credit becomes more constrained, demand is reduced, and this helps to stabilise prices."
He notes a critical delay between central bank policy decisions and their real-world impact. "The central bank adjusts its base rate monthly, not daily. During the interim, financial markets attempt to forecast these changes. These expectations themselves can drive interest rates upward, independent of official action."
This expectation mechanism directly affects mortgages. "Mortgages are linked to these anticipated rates," Dr. Spinola clarifies. "When uncertainty is high and inflation expectations rise, expected interest rates increase. Consequently, mortgage lenders begin charging higher rates, which is why borrowing costs are escalating."
If the Conflict Ends, Will Prices Fall Rapidly?
Dr. Spinola offers a sobering perspective on potential recovery. "Typically, we observe that prices do not decrease. The rate of inflation may decline, meaning prices stop increasing, but they rarely revert to previous levels," he states.
"Should the Iranian conflict cease and geopolitical tensions ease, leading to the reopening of the Strait of Hormuz, we would likely see interest rates decrease as expectations stabilise. However, a portion of the embedded inflation would persist. The situation would improve, but some damage is already irreversible."
Practical Steps for Individuals to Weather the Storm
In such uncertain times, Dr. Spinola advises a cautious and prudent approach for personal finances.
- Reduce Expenditure: "It is advisable to slightly reduce your spending. Seek out reliable saving alternatives to protect your wealth."
- Avoid Debt: "We cannot sustain spending patterns that lead to debt. If you are already indebted, rising interest rates will likely increase your debt repayments."
- Postpone Major Purchases: "If you are considering significant investments, such as buying a new car or moving house, it may be wise to postpone these plans during this period of uncertainty."
Historical Context: How Worried Should We Be?
Dr. Spinola urges perspective, drawing on historical parallels. "This is not the end of the world. We have a short collective memory, but looking back 50 or 60 years reveals numerous similar shocks," he remarks.
He cites the oil price crises of the 1970s, which were arguably more severe, along with subsequent shocks in the 1980s, 1990s, the dot-com bubble, and the 2008 financial crisis. "We have faced and recovered from a number of crises," he notes.
Reflecting on recent history, he adds, "We endured the Covid-19 pandemic, the cost-of-living crisis, and the war in Ukraine. I do not believe the current situation will be worse than those challenges." This historical context provides a crucial reminder of economic resilience even in the face of severe external shocks.
