How does a higher interest rate bring down the price of diesel?

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OpenQ : 5

How does a higher interest rate bring down the price of diesel?

On 21 October the Office for National Statistics reported that UK consumer prices rose 3.5% in the year to September, up from 3.1% in August. Motor fuels led the rise, and diesel averaged 192.5p a litre, its highest since July 2022, after the Iran war disrupted oil shipments through the Strait of Hormuz. Most economists polled by Reuters expect the Bank of England to raise Bank Rate, the interest it pays on money banks hold with it, from 3.75% to 4% on 5 November. That will not move one more barrel through Hormuz. It acts on the bargaining power of workers, firms and households that borrow.

The Bank’s July Monetary Policy Report says monetary policy cannot influence energy prices. The Bank fears the next step. A haulier pays more for diesel and raises its rates, and the supermarket that uses it raises its prices. Workers see prices rising at 3.5% a year and ask for raises, and firms pass those on. The Bank calls these second-round effects: a jump in one price becomes a lasting rise in all of them.

The same report says what holds those effects down. Weak demand, the Bank writes, contains them “by limiting companies’ pricing power and workers’ ability to bargain for higher wages.” A rate rise adds to that weakness. It leaves the price of oil alone and lowers the power of those who pay it to win the cost back.

The rise reaches them through debt. Lenders price fixed mortgages off market rates, which move before the Bank does. In July the Bank projected that a little over five million households will see their mortgage payments rise by the end of 2028, and about 750,000 leaving deals below 3% this year face an average rise of £170 a month. On the other side of each loan sits a bank or a saver who earns more. A rate rise moves income from those who owe money to those who hold it.

Some of the pressure starts where no committee in London can reach. The Bank estimates that global demand for AI hardware, including memory chips for data centres, will add a little over 0.1 percentage points to UK inflation by December. British borrowers will pay to offset that too.

So the driver pays twice for a war she did not start: once at 192.5p a litre, and again through her mortgage or her employer’s hiring freeze. The public budget pays as well. The government bonds the Bank bought are funded by a loan that pays Bank Rate, and since 2022 the Treasury has covered the shortfall, which grows as the rate rises. Every pound spent there is a pound not spent on hospitals, schools or help with energy bills.

The OpenQ

The Bank has found little evidence so far that the energy shock is spreading into pay and prices across the economy. Most 2026 pay deals were agreed before the war, so the real test is the 2027 pay round, which mostly lands by spring. The Bank has said it may need to act before that evidence is clear. The open question for the next six months is whether workers win back what diesel and energy took from them in the 2027 pay round, or whether the Bank of England raises rates first and makes sure they cannot.

Think About

The Bank’s own report says a rate rise works partly by weakening workers’ ability to bargain for higher pay. Nobody in Britain chose the war that raised the price of diesel, and nobody elected the nine people who set Bank Rate. When a shock from abroad makes a country poorer, someone has to carry the loss. Who should decide which group carries it, and should that decision sit with an independent central bank?

Ask or Reply

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