The Chancellor will be privately relieved this morning. Oil prices have tumbled to levels not seen since before the Iranian crisis, offering a welcome salve for inflation-weary markets and, more importantly, providing a tailwind for UK fiscal credibility. Brent crude slid below $72 a barrel overnight, a drop of nearly 12% from the spike triggered by Tehran’s sabre-rattling in the Strait of Hormuz. For a government that has staked its reputation on ‘sound money’ and supply-side reform, this is manna from heaven.
Let me be clear. This is not just about cheaper petrol at the pump, though that will help the squeezed middle. This is about the signal it sends to the bond market. The 10-year gilt yield has fallen 15 basis points this week, unwinding some of the premium that investors demanded after the ‘mini-budget’ debacle of 2022. The market is rewarding the Treasury’s newfound religiosity on fiscal discipline. The Office for Budget Responsibility’s latest forecasts, released alongside the Autumn Statement, showed a healthier primary balance than expected. Combine that with lower energy costs and you have a recipe for lower long-term inflation expectations.
Now, before the champagne corks pop, we must consider the mechanics. The drop in oil prices is largely a demand-side story. Global growth is slowing. China’s property crisis and the eurozone’s industrial stagnation are dampening consumption. This is not the benign supply-driven price fall of the shale revolution. It is a symptom of economic fragility. But for the UK, which imports the bulk of its oil, a demand-driven slump is still a net positive, at least in the short term. It reduces the trade deficit and takes the heat off sterling, which has been flirting with $1.30.
More importantly, it buys the Bank of England time. Governor Andrew Bailey has been walking a tightrope between suppressing inflation and avoiding a hard landing. With CPI still above 4%, he cannot cut rates yet. But lower energy costs will drag down headline inflation automatically, perhaps allowing the Monetary Policy Committee to hold rather than hike. The market is now pricing in the first rate cut for August 2024, earlier than previous estimates. That is a direct consequence of the oil price move.
Critics will argue that the government is getting lucky. That discipline alone does not explain the reversal in sentiment. They have a point. The Truss premium has taken the gilt yield from 4.5% to 3.8%, but it would have fallen further if not for the stubborn core inflation data last week. The UK still has a structural productivity problem and a demographic time bomb. But the market is a short-term beauty contest, and right now, it likes what it sees: a Chancellor who sticks to his fiscal rules and an economy that is rebalancing away from energy dependence.
Capital flight had been a concern in the summer, with foreign investors reducing their holdings of UK gilts. That trend has reversed. The latest data from the Bank of England shows non-resident purchases of gilts rose by £9.4 billion in October, the highest in 18 months. The oil price crash has made UK assets more attractive on a relative basis. With German bunds yielding a paltry 2.1% and US Treasuries volatile, British paper offers a decent premium with a credible anchor.
Of course, we must not get carried away. The geopolitical risk from Iran has not vanished. A new flare-up could reverse these gains overnight. And the structural issues remain. But for now, the square-jawed fiscal restraint of the Treasury is being rewarded. The oil price is doing the heavy lifting, but the Chancellor can take a bow. The markets are no longer betting against Britain. They are cautiously buying in again.
