What do higher oil prices mean for the U.K.?

Investing.com -- U.K. oil prices have risen 7% amid growing geopolitical tensions, bringing prices back to levels seen at the start of 2024, according to Deutsche Bank (ETR:DBKGn) analysis.

This price increase is expected to have a dual effect on the U.K. economy: slightly lower growth and higher inflation. As a net importer of both crude oil and petroleum products, the U.K. is vulnerable to oil price shocks despite still producing significant amounts domestically.

Based on various research estimates, a permanent 10% increase in oil prices would reduce UK GDP by approximately 0.2%. With the current 7% rise, the impact on GDP would be marginal at about 0.1%.

Elevated household savings rates may help buffer this temporary shock, with cash excess savings exceeding £200 billion and the household savings rate above 10% in Q4-24.

The inflation impact is expected to be more significant. Bank staff estimates suggest a 10% oil price increase raises U.K. CPI inflation by 0.2-0.3 percentage points, while Office for Budget Responsibility (OBR) estimates indicate a slightly stronger effect of 0.3 percentage points.

Deutsche Bank’s models suggest a 10% rise adds 0.23 percentage points to year-ahead inflation, with the impact front-loaded in the first quarter before dissipating within a year.

For fiscal policy, the effects are nuanced. Higher oil prices increase offshore corporation tax receipts and Energy Profit Levy tax revenues, though this is partially offset by lower fuel duty revenues due to reduced demand.

Deutsche Bank estimates that after accounting for negative economic impacts, a 10% permanent rise in oil prices could lead to a £0.3 billion reduction in the Chancellor’s fiscal headroom.

The OBR’s March conditioning assumptions included Brent oil prices around $70.1 across the forecast horizon, similar to current levels. The concern would be if prices rise significantly above these projections.

Regarding monetary policy, while central banks typically wouldn’t react strongly to energy price shifts, the current environment is different.

With inflation expectations still elevated and headline CPI sitting around 1.5 percentage points above the Bank of England’s 2% target, sustained higher oil prices could push inflation expectations higher and potentially lead to a slower removal of policy restrictions.

Deutsche Bank expects inflation to average 3.3% year-over-year for the remainder of the year, with inflation expectations playing a crucial role in shaping 2026 pay settlements.