Government bond markets around the world have recorded some of their most dramatic moves in years as the oil price surge triggered by the Iran conflict reignites fears of a new wave of energy-driven inflation. In the UK, yields on five- and ten-year bonds recorded their biggest weekly jump since the Liz Truss mini-budget crisis of September 2022. In the eurozone, the weekly rise was the largest since March of the previous year.
The bond market’s reaction reflects a fundamental reassessment of the inflation and interest rate outlook. When oil prices surge more than 25% in a single week — as they have following the Iran conflict — the inflationary implications are profound and wide-ranging. Energy costs feed through to virtually every part of the economy, from transportation and manufacturing to food production and retail. Higher oil prices mean higher inflation, and higher inflation means interest rates need to stay higher for longer.
This logic has devastated interest rate cut expectations. In the UK, the probability of a Bank of England rate cut this month fell from 80% to just 15% in the space of days. European money markets have reversed from pricing in cuts to pricing in a possible rate rise from the ECB by year’s end. For bond markets, which had been pricing in a world of declining rates, this reversal has been painful — hence the surge in yields.
The oil price surge is being driven by a confluence of factors stemming from the Iran conflict. Kuwait has been forced to cut production at storage-full fields, and Saudi Arabia and UAE face the same situation within 20 days. Qatar’s LNG exports have been disrupted, sending European gas prices to three-year highs. Qatar’s energy minister has warned that continued conflict could push oil to $150 a barrel, a level at which inflation consequences would be even more severe.
Stock markets have added to the week’s financial chaos, with Asian indices recording their worst week since the pandemic and European and UK stocks falling more than 5%. Gold fell around 3.5% — an unusual move for a crisis period that likely reflects the strength of the dollar rather than a lack of concern about the economic outlook. The bond market’s verdict is clear: the Iran oil crisis has fundamentally changed the near-term economic and monetary policy landscape.