BOE sees weather as new inflation risk while London sizzles

As LONDON bakes in record-breaking sunshine, Bank of England officials are beginning to fret that, as one supply shock dissipates, the weather could produce the next one to push up inflation.

Climate scientists increasingly expect a severe El Nino event disrupting global weather patterns will take hold later this year and into 2027. Now economists are beginning to worry that it could cause the next supply shock that boosts food inflation and provide the latest setback for central banks.

“The exposure here in the UK is more about what we import than anything else,” said David Owen, founder of Saltmarsh Economics — a consultancy focusing on climate economics.

“You’d get things like droughts impacting parts of the world so obviously that would impact their ability to produce agricultural food,” he said, adding: “It might also have a major impact here in the UK directly.” 

The threat of high inflation this year is fading after the US-Iran truce sent energy prices sliding and allowed ships to pass through the Strait of Hormuz. That’s prompted some economists to believe that the BOE could resume rate cuts next year.

However, there are signs that officials at the UK central bank are growing concerned about the impact of a stronger than usual El Nino if it causes droughts in some areas and flooding in other parts. That could set back plans to reduce rates if it causes UK inflation to spike again in 2027.

The rising inflation threat posed by shifting climate patterns jars with the recent path taken by the BOE, which has slashed spending on climate work as it tries to ease its strained finances. The bank has also shelved plans to regularly stress-test banks on their exposure to climate change and the net zero transition.

El Nino is an irregular phenomenon that typically occurs every two to seven years and lasts nine to 12 months.

Characterised by higher sea surface temperatures in parts of the Pacific off the South American coast, it slows trade winds and affects weather patterns around the world, increasing rainfall and flooding in some parts of the globe and bringing drought conditions to others.

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The US Climate Prediction Center this month put a 63 per cent chance of the weather phenomenon becoming a very strong event, dubbed by some scientists a “super” El Niño, in late 2026 and early 2027. 

It prompted BOE rate-setter Swati Dhingra to warn this week that such an event “raises the risk of higher global prices for weather-sensitive crops such as cocoa, edible oils, sugar, rice and coffee.”

“The drivers, the consequences, and the solutions to climate change are all relevant to price stability,” she said in a speech. “These channels are becoming more material over time.”

Central bankers watch food prices carefully, alongside energy costs, because it is particularly pertinent for household inflation expectations.

Shoppers buy food frequently and therefore notice rapid and large price changes more than for products they purchase only occasionally, such as a new TV or laptop.

A spike in headline inflation driven by food is therefore a bigger risk for households’ price expectations, raising the prospect of second-round effects if it causes consumers to demand higher wages.

Britain is also more vulnerable to global supplies given its heavy reliance on food imports. Food arriving from abroad accounts for around 40 per cent of the UK’s supply, according to government figures.

Owen at Saltmarsh said Dhingra “knows it represents another supply shock and obviously supply shocks complicate monetary policy decisions.”

“If it’s almost certain there’s going to be one this year, which then impacts food prices and other things into 2027, then obviously policymakers need to be thinking ahead about it,” he said.

For now, UK food inflation remains subdued. It fell to 2.1 per cent in May, the lowest since late 2024 and well below the peak of almost 20 per cent in 2023. However, it could soon become a source of concern for the central bank and a new UK prime minister if it reignites angst over the cost-of-living.

A recent report co-authored by BOE official James Talbot included modelling that suggested a global El Nino scenario would see droughts that reduce economic output and increase inflation.

“Repeated and increasingly severe shocks can produce persistent and compounding effects on inflation and output over time, exacerbating monetary policy trade-offs,” the report for the Network for Greening the Financial System said.

Still, the impact is likely to be larger in developing countries where food makes up a bigger share of the inflation basket.

“In Asia and parts of Latin America, the transition to lower inflation will be complicated by the impact of El Nino, which is expected to cause extreme weather, affecting agriculture and in some cases hydroelectricity, resulting in higher food prices,” said Claire Dissaux, head of macro research at AXA Group.

“This new supply shock coming on top of the recent rise in energy and fertiliser prices could tip the balance towards monetary policy tightening.” BLOOMBERG