UK seeks to limit economic hit from Iran as borrowing costs jump

By Sam Tabahriti and Sarah Young

LONDON, March 9 (Reuters) - Britain wants major economies to agree to release emergency oil reserves as the escalating Iranian crisis sends energy prices soaring and increases the risk of higher inflation, finance minister Rachel Reeves said on Monday.

British borrowing costs have soared since the conflict erupted more than a week ago, and by more than those of other European countries and the U.S., as investors fear that surging oil and gas prices will stoke already stubborn inflation and require the government to borrow more.

Prime Minister Keir Starmer warned that a prolonged crisis would hurt the economy, on a day when short-dated British government bond prices were at one point on track for their sharpest daily fall since the market crisis that brought down his Conservative predecessor, Liz Truss.

"The longer this goes on, the more likely the potential for an impact on our economy," Starmer said.

Interest rate futures on Monday suggested investors no longer expect the Bank of England to cut rates this year. Bond prices had recouped most of their losses by the end of the day as oil prices fell from an earlier peak.

QUESTION MARK OVER HOUSEHOLD ENERGY SUBSIDIES

The jump in energy prices threatens to force the government to intervene to cushion the economic blow, a potentially huge challenge as it has limited room to increase spending and is widely unpopular.

Starmer told an event in London on Monday that the government was trying to limit the fallout.

"The chancellor (Reeves) is talking with the Bank of England every day to make sure that we're ahead of that, on energy prices for households."

Earlier on Monday, G7 nations said they were prepared to implement "necessary measures" in response to surging global oil prices, but stopped short of committing to release emergency reserves.

Reeves subsequently told parliament that she wanted to see "a coordinated release" of International Energy Agency reserves.

"A rapid de-escalation in the Middle East remains the best way to protect us from rising energy bills, but as the situation continues to unfold my priorities will continue to be helping families with the cost of living and protecting the public finances," she told parliament.

Reeves added that energy price rises "were likely to put upward pressure on inflation in the coming months" and that she was speaking with insurers Lloyd's of London over shipping through the Strait of Hormuz.

Britain's economy is particularly exposed to the price of gas and already has the highest inflation in the G7. When energy prices spiralled after Russia's 2022 full-scale invasion of Ukraine, the then Conservative government was forced to spend more than 40 billion pounds ($53 billion) on subsidies.

Most British households are protected until July from the immediate impact of higher gas prices on heating and electricity costs, due to regulated tariffs.

But U.S. bank Citi estimated it would cost the government around 9 billion pounds if it wanted to cap these consumer tariffs at their current level over the next two years, roughly double what it estimated last week.

Deutsche Bank estimated that without intervention, higher energy prices would boost inflation by 1 percentage point and reduce economic output by almost 0.5%, a sizeable amount in an economy previously only forecast to grow by about 1%.

($1 = 0.7496 pounds)

(Additional reporting by Catarina Demony and William James; writing by Sarah Young, Kate Holton and David Milliken; Editing by Andrew Heavens)