Why the US’s Iran-fuelled inflation is trouble for Trump (and the UK)

0:02Sky News, the full story first.

0:11Trump's war on Iran is beginning to cause problems for everyday Americans. And this is why.

0:27Have you ever done something that seemed like a good idea at the time, then massively backfired? Well, that's maybe how Donald Trump is feeling at the moment, as his war in Iran begins to have an economic impact in the US. I love the inflation. You know why? Because as soon as this war is over, it's coming down. I know you can't. It's going to come down like a rock. Despite his characteristic bombast, this is actually bad news for an America first president who sold voters a dream of not only avoiding foreign wars, but also bringing in a so-called golden age for the US economy. The US is the biggest exporter of oil in the world.

1:11So why is it being hit so hard by the effective closure of the Strait of Hormuz? And what could this all mean for Trump's presidency? And whatever America is feeling, the UK and Europe will feel it even worse. I'm Mari Arora, and I'm joined by our business and economics reporter, James Sillars. Talk me through the latest inflation figures for the US and what they mean and what's behind them. So we've seen since the war began, inflation creeping up pretty much everywhere. And in America, it's the world's biggest oil producer. So you would think in some respects that it's immune from inflation and all these big energy price shocks that we're seeing, but it's not.

1:56It needs certain types of oil just as much as anyone else. So because it started the war, people were looking at the United States and sort of saying, well, you know, what are you doing? What are you doing? You know, you're just going to create a big price shot. Donald Trump, you know, has made this huge thing of low interest rates, low inflation, getting as much growth as possible. But, you know, what these inflation figures yesterday in the United States did was just show exactly why, you know, if you start a war that's energy-based, you're going to face higher costs. And we saw the rate of inflation rise from 3.8 % to 4.2%.

2:33So it was a big old lift. Prices for American consumers are on the up. The higher the rate of inflation, it's higher now than wage growth. So you really start to feel the pinch. That's the key equation, isn't it? When inflation overtakes your wage growth, essentially, you have less money to spend to buy your essentials. And that is what impacts people's real lives. Yeah, I mean, Americans love their cars. And when gas prices go up, as they call it, then they start to moan. And it's really affected Donald Trump's approval ratings. So in terms of the timings, why has it taken so long for the US consumer to start to feel it?

3:13Because obviously, this war didn't happen yesterday. But it seems the impact has been a bit delayed? Well, this is the thing about inflation. It takes time for prices to move. So, for example, you've got base oil that has to be refined into a product, whether that be unleaded, as we call it in this country, or diesel. And then that goes through, and we saw it in this country, go very quickly through to the consumer. I mean, petrol prices here were rising within 48 hours of the war beginning. I mean, that was how quick the reaction was. And it was the same in the United States. The issue for a lot of people is when that then begins, that cycle, if you like, begins, it then filters through into wider prices in the economy.

4:00So it means that the transportation of goods from factories goes up. You've got the cost of raw materials going up. So everybody is paying a higher price further down the supply chain. And then it reaches the consumer and everybody's piled in and added a bit more cost. It's kind of compounding. Exactly. Exactly. So that's the problem. So it takes time for inflation to feed through. So I was reading this morning that actually, because in America, gasoline prices are now going down, there's a school of thought now that perhaps inflation is peaking, because oil prices have come down from those wartime highs that we saw in March and April.

4:41So perhaps it's peaked in America. That's not necessarily going to be the case here. So in terms of that timing then, the prices have gone down in the US. Do we think that's likely to continue to go down in the US or is it too early to say we don't even know what's happening? I mean, the Iranians have said that the Strait of Formos is closed to all marine traffic following those new attacks last night. So if the Strait reopens, how long would it take to recover? And let's say it doesn't reopen, or at least not yet, does that mean prices could go back up again? It all depends on the straighter foremoods.

5:15You know, a fifth of the world's oil and gas normally flows through the straighter foremoods. You've had attacks on Gulf state energy infrastructure. That's going to take years in some cases to fix. This is not a quick fix at the minute. You know, first thing you need the straight open. You can release some of the other oil tankers and other shipping that's all at anchor off the UAE coast and the Omani coast. The thing is then getting supplies back to normal. In fact, there was some really interesting research from Barclays this week where they were saying in terms of average oil prices, we're still looking potentially average oil prices above$100 a barrel, you know, next year, if the Strait of Hormuz reopens around now, because there's still going to be that squeeze on supply.

6:03I think the world's actually coping better than was expected. Now, we've had these emergency releases of reserves. We were all panicking a few weeks ago, are we going to be able to go on our summer holiday? I don't think it's been as bad as people initially expected, because production has been ramped up in other places to sort of offset the losses. So I don't think it's been that bad. But the longer we go towards the northern hemisphere winter, and we still don't have the Strait of Hormuz open, the more I think we're going to be facing squeezes. Yeah. And also, I suppose, if we started to kind of rinse our reserves, then also that feeds into the prices as well.

6:44If we've kind of not depleted, but let's say we've used up more reserves than we normally would, then that also contributes as well, right? Yeah, absolutely. And, you know, we are using up reserves. And this is the thing, you know, are we facing fuel shortages, you know, here, for example, over the coming winter? It's very, very difficult to say because we are at the mercy of the international market. We're competing with others for a certain amount of refined product. And it's the same in America. They have massive refining capacity, but they need a certain type of oil to make gasoline, just like everybody else.

7:17In this country, we've actually shot ourselves in the foot because we've lost so much of our own refining capacity. We're importing the vast bulk of diesel that we need in this country now. We don't make diesel anymore in the way that we used to only a few years ago. So this is going to be the big thing coming into winter. Are we going to be able to meet demand for things like possibly diesel? So when it comes to the US economy, are they somewhat cushioned or protected by, A, what you were saying about the fact that they produce so much of their own oil, and B, the fact that actually their growth projections are looking quite good.

7:58I mean, God, we would kill for those kind of growth projections here in the UK. Absolutely. I mean, you know, the American economy is projected to grow by 2 % this year. You know, we're looking at below 1%. You know, that's where our projections currently are. And one of the reasons why America's economy will be doing so well is they are pumping record volumes of oil and gas to help try and make up some of the shortfall from the Strait of Hormuz. And of course, they're getting excellent prices for it as well. So they're doing quite well out of it. Here, in this country, we rely a lot more on consumer spending.

8:34We don't have such a big manufacturing base. We rely on consumer spending. And when consumers are feeling the pinch here, our economy feels the pinch. Donald Trump has been really critical of Keir Starmer several times, hasn't he, about energy policy. He keeps saying you're getting killed on energy, getting killed on energy. Is Trump right on that? Have we made ourselves far too vulnerable to the international markets when we've had two wars in the space of just a few years, both triggering huge energy shocks? It all forms part of that big energy debate, and it still rages here in this country.

9:10Should we be drilling more in the North Sea to help bring prices down. The difficulty is that even if we were to ramp up North Sea supply, it still gets sold on the international market. And the volumes would be such that it wouldn't make a vast difference to prices. Yeah, it's not going to be this kind of game changer that some people argue it could. Look, the United States runs on oil. It glugs it down and it's producing more and more and more. you know and it is not a resource that obviously is sustainable and everyone wants to try and bring global emissions down in this country we've taken the view that we don't want to leave ourselves at the mercy of the oil and gas markets so we have gone down the route of particularly wind power offshore with a bit of new nuclear in the mix as well and in america they're just basically burning more oil.

10:07Yes, it will bring and it will keep costs down to a certain extent. But at the end of the day, is that policy sustainable in the longer term? And the answer is no. Let's talk about politics in the US for a moment, just in relation to the US economy. So we've got the midterms coming up, surely a big concern for Donald Trump. How much of an impact do you think the US economy and the Iran war could have on those elections? You've got a scenario now where the market is now beginning to price in the possibility of an interest rate rise towards the end of the year, which, you know, you've got the midterms November, isn't it?

10:47You've got higher inflation, so people feeling it in the pocket. And I don't think there is any way you can get away from the fact that, you know, the reason why Donald Trump has been so desperate to secure peace. I mean, of course, we've had skirmishes over the last few days. But I think the reason he's had ceasefires in place since April is that he underestimated the Iranians completely. And he now is eyeing the future and what the second part of his final term is going to look like. Yeah. And the prospect of losing control of Congress, that would really curtail his ability to essentially do what he wants.

11:25So in terms of the American economy, growth has been okay. It might slow a little bit, but it's okay. Inflation will be elevated. And what Americans will not want to see is an interest rate rise to try and help keep a lid on some of this inflation. And the difficulty Mr. Trump has, you know, he had a huge row with now former chair of the Federal Reserve, Jay Powell. Yeah, I mean, he's been criticising him. He wanted to sack him. He wanted him out. Jay, he's a very bad guy, doesn't know what he's talking about. You know, that was all the messaging that we had from him. And that was because he didn't want to do what Trump wanted him to do.

12:03Well, I mean, no, he was just basically doing his job. I mean, which is, you know, to manage monetary policy. So Jay Powell basically is the Andrew Bailey of America. Andrew Bailey, of course, is the governor of the Bank of England. And what Jay Powell was doing was just, you know, playing it like a top central banker would. You know, you're just doing your job. You know, you act according to the situation that you find yourself in. So Donald Trump nominated a new Fed chair, Kevin Walsh. Actually, somebody that the market thought, you know what, that doesn't sound like a political appointee who would come in and just say, no, interest rate cut, interest rate cut, interest rate cut, to try and inspire growth in the American economy at any cost.

12:47That's not what Kevin Walsh is seen as. You know, he was actually very well received by the market. He survived the vetting process through Congress really well. So he's got his first meeting, Kevin Walsh, next week as the new Fed chair. He's not going to necessarily, the news conference that follows it, I think, want to give Americans a message that, you know, things are about to get really tough. But I think he will want to set out and probably calm some in the market who may well think that now he's in there, actually, is he going to misbehave and do what Donald Trump wants, which is to cut baby cuts, you know, and I don't think he will.

13:26Okay, so let's zoom out for a sec. Here in the UK and across Europe, we're probably expecting interest rates to rise. My own personal view is that I don't think the Bank of England necessarily has to act at all. And this is why. And it's because we already have a fairly restrictive bank rate of 3.75%. Unlike the European Central Bank, which has gone all the way back down, I think it's 2%, the deposit rate. We have had much stickier inflation in the UK. And this has been why the UK bank rate has remained higher for longer. So at 3.75%, and with an economy that is only predicted to slow, you've got a weakening labor market, rising unemployment.

14:11I'm not sure the Bank of England will take a view towards the end of the year that bank rate needs to go up. Why choke off the small amount of economic growth that you already have? Why risk rising unemployment further by raising rates if you don't have to? If we see signs of what they call second round effects, then we may well have to act. Things like rising wages, core inflation, services inflation, those numbers starting to tick up a bit. My personal view is I don't think we'll see an interest rate rise here in this country this year. Okay, you heard it here first. James, thank you so much.

14:54Cheers, Barry. Now that's all for today. Don't forget to send your episode suggestions to why at sky.uk and follow This Is Why on your podcast app. And we'll be back again tomorrow.