UK business costs are surging at their fastest pace since the pandemic, with the latest ONS Producer Price Index jumping from 0.7% in February to 5.4% in March. The spike has been driven largely by a 59% surge in crude oil prices, an early signal of how geopolitical shocks — particularly the US-Israel-Iran conflict — are already filtering into the economy.

Producer price increases typically mark the early stage of an inflationary cycle. Over time, higher input costs are passed through to consumer prices, feeding through to inflation at the tills and creating upward pressure on wages. Unless productivity rises sufficiently to expand supply and absorb higher pay demands, the result is more money chasing a relatively fixed pool of goods and services. This dynamic is the classic setup for wage-price spirals, as seen in the Seventies.

Britain is in a particularly vulnerable position entering this phase because of its large balance of payments deficit. The IMF projects this will reach 3.4% of GDP this year, driven by higher import costs, which is likely to put downward pressure on the pound. The economy faces a double hit: not only are goods and services becoming more expensive in absolute terms due to the conflict, but a weaker currency is also amplifying those price increases by making imports more costly.

This creates a difficult policy dilemma for the Bank of England. The standard response would be to raise interest rates to prevent a wage-price spiral from taking hold. However, doing so risks further suppressing already weakening business investment. That runs counter to broader economic needs, where the priority would normally be to boost production as a way of easing inflationary pressure. It is this trade-off that explains the Bank’s cautious stance on further rate rises, including signals from Governor Andrew Bailey.

The alternative is to try and ride out this inflationary spike as a one-off event and keep interest rates steady, as some economists have predicted. This is not without cost, as a one-off hit like this would hit households hard. In fact, real disposable household income per head is still lower today than it was in 2021 due to the pandemic and war in Ukraine.

A more forceful policy mix would involve tighter interest rates to bring inflation under control, support the pound, and help ease import-driven price pressures. This could be conducted alongside fiscal measures to sustain investment by providing cheaper credit to firms. This would be particularly important in sectors such as oil and gas, petrochemicals, critical minerals, and food, where inflationary pressures are likely to be most acute.

The reality is that households are likely to feel the effects of the conflict over the coming year regardless of policy choices, given the economy’s starting position of vulnerability. The most that can be achieved is to safeguard and expand productive capacity so that the economy emerges stronger than it entered the crisis. That requires a longer-term, more strategic approach from both central banks and policymakers.

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Andrew O’Brien is the former Director of Policy at the think tank Demos and currently Head of Secretariat of the Independent Commission on Neighbourhoods. He writes in a personal capacity.

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