UK interest rates – Opec to the rescue?

The Bank of England may struggle to justify multiple rate cuts this year unless the oil price stays relatively low

Ahead of tomorrow's interest rate decision by the Bank of England, not nearly enough attention has been focussed on the price of oil - and the reasons behind recent changes in oil prices.

Movements in the cost of oil are, of course, a key determinant of UK inflation - which, in turn, is obviously central to the future path of interest rates set by the Bank’s Monetary Policy Committee (MPC).

The oil price dropped 18pc during April – the biggest monthly decline since November 2021 – to around $60 a barrel. Fears that diminished trade in the wake of Donald Trump's tariff war will undermine global growth – hitting worldwide energy demand – are dragging down oil prices.

But another much less-discussed reason why crude has lately got much cheaper is an ongoing power struggle within Opec, the twelve-nation oil exporters’ cartel.

On Thursday, the Bank of England looks certain to lower interest rates again, from 4.5pc to 4.25pc. The monetary policy committee (MPC) has already reduced benchmark borrowing costs from 5.25pc last summer.

But the Bank recently predicted rising energy prices will soon push UK inflation up sharply, from 2.6pc in March to 3.7pc later this year – almost double the 2pc target. That means the MPC may struggle to explain further rate reductions beyond this month – even though the economy is in the doldrums and lower borrowing costs would be widely welcomed.

If internal rows within Opec continue, though, could resulting low oil prices keep a lid on UK inflation – helping to justify rate cuts in the summer and autumn too?

Oil Slip?

Brent crude fell from over $74 per barrel at the start of April to just over $60 at the beginning of May, with oil prices now at a four-year low.

Part of the reason was “Liberation Day” – April 2nd – when Donald Trump announced sweeping tariffs on foreign goods sold in America. Since then, the US President's audacious (many would say reckless) bid to recast the global trading system through punitive levies has fanned fears of a global recession.

Much diminished trade and a related world-wide growth slowdown would indeed weaken energy demand, the prospect of which has weighed heavily on oil prices. But another reason crude has become cheaper in recent weeks has garnered far fewer headlines, despite being much more significant – namely the ongoing power struggle within the Opec oil exporters’ cartel.

And even if perceptions of Trump's policy antics shift, and the US does manage to strike a series of new bilateral trade deals, boosting the global growth outlook, this ongoing row within Opec means oil prices may remain relatively low regardless.

US-China stand-off

For now, the US and China remain locked in an alarming stand-off – with tariffs of up to 145pc and 125pc respectively on each other's goods exports. A prolonged trade war between the world’s two largest economies, generating over two-fifths of global GDP between them, would of course be disastrous.

America’s economy contracted 0.3pc during the first quarter of this year, figures released last week showed, sharply down from a 2.4pc expansion over the previous three months. This has intensified concerns that Trump’s trade policies will cause US GDP to fall during the second quarter too, driving America into recession.

China’s GDP growth was still a buoyant 5.4pc during the first three months of 2025 – but the current near standstill in Sino-US trade is now biting, given that America is China’s biggest export market. Already, China's manufacturing Purchasing Managers' Index, a key survey of business leaders, fell sharply to 49.0 during April, down from 50.5 in March – with readings below 50 signalling economic contraction.

China's growth outlook impacts global oil markets heavily – it is by far the world’s biggest crude importer. So the steep oil price drop in April was driven by fears not only of a US slowdown, but also trade difficulties facing the People's Republic and other major exporting economies too.

Nanjing Road, the main shopping district of Shanghai

Opec’s “rogue producers”

Yet last month's 18pc fall in crude prices also reflects ongoing efforts by Saudi Arabia to discipline Opec’s “rogue producers” – and this is where the story gets really interesting.

Like all cartels, Opec – which controls around 40pc of global oil output – exists to keep prices relatively high, benefitting oil exporters. But Saudi, the group's production lynchpin, is now trying to punish member states who have been “cheating” or “free-riding” – that is, pumping and selling beyond their allocated output quotas, in a bid to make more money, while other members have stuck to agreed production limits to keep prices firm.

That's why, in a reversal of normal practice, key Opec members led by Saudi recently voted through higher production for the whole group, hoping that the ensuing price declines would then force the quota-busting troublemakers, which tend to be much poorer economies, to toe the line.

Riyadh has used such tactics before – during the mid-1980s, the late-1990s and as recently as 2020. Since then, Saudi has aggressively backed production controls designed to stabilise oil at around $90 per barrel – the level ultimately needed to balance the books of Saudi's big-spending government.

Despite Opec's warnings, though, Kazakhstan and Iraq in particular have lately been breaking quotas – with Kazakhstan in particular showing record pumping figures over recent months, as US firms Chevron and Exxon Mobil have expanded production at key fields in the country.

The UAE has also been “cheating” beyond its Opec quotas, according to many oil industry insiders – although, for various reasons, Riyadh has been reluctant to call out its near neighbour, the second-largest economy in the region after Saudi.

In response to quota-busting, Opec raised output by 130,000 barrels a day during April, before announcing an even sharper increase of 411,000 barrels daily during May. And when Opec met last weekend, it went even further, adding another 411,000 barrels per day of output during June.

So having announced a 2.2 million barrel per day production cut in 2023 to push prices up, Opec has over recent months reversed an estimated 952,000 (or 43pc) of that reduction, largely to try to punish cartel members who are breaching quotas.

While 952,000 barrels per day is less than 1pc of total global oil supply of around 102 million barrels daily, that is more than enough heavily to impact current oil prices and, crucially, forecasts of where oil prices will go.

The Opec exporters’ cartel controls around 40pc of global oil production

Markets have calmed

It may be – as I suggested here on “When The Facts Change” the day after Trump’s original tariff annoucement – that current US trade policies don’t spark the prolonged economic chaos so many are predicting. There are signs a US/India trade deal may soon emerge, for instance. And even China is signalling to the White House it may soon be ready to talk.

Financial markets, roiled by Trump’s initial tariff announcements in early April, were recently calmed by his decision to postpone heavily punitive levies on most countries, while maintaining his 10pc tariff on US imports across the board. Since then, equities have surged, with the S&P 500 index of leading US shares having now recovered to where it was just before Liberation Day – even though Trump's 10pc universal tariff remains in place, along with the looming threat of his generally much higher “reciprocal tariffs” as well.

The 10-year US Treasury yield is also roughly back where it was at the start of April – despite lots of previous headlines about a “bond market meltdown”. And America’s latest GDP number was surely a blip – caused by a 41pc surge in US imports during the first quarter, as firms scrambled to get ahead of a new more punitive US tariff regime that Trump had been signalling for some time.

So the recent oil price fall has been only partly caused by panic surrounding Trump’s trade policies. But it strikes me that even if fears about his new trading regime continue to abate, and the global growth outlook recovers, intra-Opec politics could still keep oil prices relatively low, with the usual knock-on effects to other energy markets.

Thursday’s UK rate cut looks “nailed-on”

Financial markets and analysts widely expect a 25-basis-point cut on Thursday, reducing the UK base rate from 4.5pc to 4.25pc. Inflation in March, at 2.6pc, was down from 2.8pc the previous month. And, despite the MPC holding interest rates when the nine-member committee last met in March, Governor Andrew Bailey has indicated that benchmark borrowing costs are “on a gradually declining path”.

Some analysts are predicting a more aggressive 50-basis-point reduction to 4pc – although they are mainly based at investment banks and other financial services firms, where the culture is often to over-egg forecasts of lower future rates in order to juice up financial markets and boost sales. It strikes me, in contrast, that with inflation predicted to rise, though – not least that 3.7pc Bank of England forecast – the MPC may struggle to justify further cuts beyond this month.

Yesterday the April 2025 S&P Global UK purchasing managers index survey was published. This suggested the UK services sector, accounting for around four-fifths of the economy, shrank last month, following a 17-month period of expansion - as the index fell to 49.0 last month, down from 52.5 in March.

But the same PMI survey also pointed to inflationary pressures, namely a significant increase in firms’ costs, with input prices hitting a 26-month high. This was largely driven by rising payroll costs – in turn reflecting policies announced in Chancellor Rachel Reeves's Budget of October 2024 but introduced last month, namely the sharp hike in both the minimum wage and employer national insurance contributions.

The UK benchmark interest rate is widely expected to fall from 4.5pc to 4.25pc on Thursday 8th May, having already come down from 5.25pc last summer

Opec to the rescue - for now?

So, in summary, we are very likely to get an interest rate cut from the Bank of England tomorrow – from 4.5pc to 4.25pc. The decision will be announced not at 12.00pm, by the way, but at 12.02pm. This is to allow for the two-minute national silence at noon to mark the 80th anniversary of VE Day.

Despite ongoing inflationary pressures in the UK, energy prices play such a key role in driving economy-wide headline inflation that I suspect recent oil price reductions mean the Bank of England may tomorrow announce it has revised down its forecast of where inflation will peak later this year – from 3.7pc to 3.5pc or even lower.

The UK economy is facing some very stiff headwinds - not just on the overseas front, with tariff turmoil and lots of geopolitical uncertainty. But the government's policies are now also seriously impacting growth – with even Britain's usually robust services sector succumbing to sharply increasing pay-roll costs.

If internal rows within Opec continue, though, as obscure as they seem to many, then that may help keep oil prices – and, crucially, expectations of future oil prices – low over the coming months, even if the global trade policy environment becomes less alarming.

Lower oil, given the impact that cheaper crude tends to have on the price of other fuels, may then keep a lid on UK inflation. And that, in turn, would help the Bank of England to justify further cuts to base interest rates in the summer and autumn too.