# Pavlovian central banks; the stealth tax squeeze

_Gulf oil exports are back at pre-war levels, yet Brent is above $100 again. Central banks reach for rate rises, an MPC hawk worries about wages the ONS says are slowing, and frozen tax thresholds keep doing the Chancellor’s work._

Neil Woodford · 9 October 2026 · 9 min read

![A dog licks its lips looking at its food bowl while a bell sits off to one side.](https://cdn.sanity.io/images/v3acfbvo/production/89985ad4e245eee34095be792d7941cb9f637e48-1448x1086.png?w=1600&fit=max&auto=format)

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This week has been more than a little taxing for those with a more optimistic economic outlook, as [oil prices have jumped once again above $100 per barrel](https://oilprice.com/Latest-Energy-News/World-News/Oil-Jumps-2-as-Iran-Steps-Up-Attacks-on-Hormuz-Tankers.html) following increased tension in the Persian Gulf. UK gas prices have followed suit and increased to just below 200p per therm, testing the recent highs reached in September. Naturally, this has fed into higher bond yields everywhere, with [ten-year Treasuries now yielding 5.35%](https://www.forbes.com/sites/garthfriesen/2026/10/07/why-the-10-year-treasury-yield-just-hit-a-24-year-high/) and [ten-year gilts yielding 5.5%](https://www.vantagemarkets.com/market-news/uk-10-year-gilt-yield-19-year-high-5-53-percent-after-oil-jump-october-9-2026/). Aside from this familiar sequence of events, there hasn’t been that much grabbing the attention of global financial markets.

Not surprisingly, this renewed tension in global energy markets has triggered more bearish commentary about the outlook for the UK economy (and others, of course), [more speeches from hawks on the MPC](https://money.usnews.com/investing/news/articles/2026-10-08/dangerous-for-boe-to-rely-on-high-bond-yields-to-control-inflation-mpcs-greene-says) and more apocalyptic warnings about the need to raise taxes to refill the UK’s fiscal headroom, given that [it’s probably halved](https://www.investmentweek.co.uk/news/4536029/pressure-mounts-healey-uk-fiscal-headroom-forecast-drop-12bn) from March’s £24bn to about £12bn now. In this week’s update, I will comment on all of these issues, alongside a couple of related ones linked to the worrying implications of stealth taxes in the UK.

## More oil, and a higher price

So first to renewed tension in the Persian Gulf. Following [a recent increase in the number of Iranian attacks on shipping](https://www.thenationalnews.com/business/2026/10/08/hormuz-traffic-hits-lowest-level-in-two-months-as-tanker-attacks-surge/) passing through the Strait of Hormuz, there is [speculation that there will be some kind of US military intervention](https://www.nbcnews.com/politics/national-security/us-military-prepares-new-iran-war-options-ahead-midterm-elections-rcna601725) ahead of the midterm elections at the beginning of next month (3 November). This has led to the recent spike in oil prices to $105 a barrel, despite the fact that [the volume of shipments leaving the Gulf region](https://www.kpler.com/blog/explainer-how-mideast-gulf-crude-exports-returned-to-pre-war-levels), including crude and refined products, has continued to increase from the lows of March.

![Back to pre-war volumes, with 40% going around Hormuz](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-weekly-8oct26-gulf-routes-29e4b3702c40-light.png)

_March averaged about 6 million barrels a day, 10.5 million less than September. More than 70% of the crude that crossed the strait in August changed tankers offshore in the Gulf of Oman._

_[Embedded media](https://www.bbc.co.uk/news/articles/cwp8gn13lmygo)_

Not only have volumes recovered, as you can see in the chart above, but it’s also clear that countries in the region have been very successful in getting crude out without the need to transit the strait. Indeed, [that volume now accounts for 40% of the region’s crude](https://www.kpler.com/blog/explainer-how-mideast-gulf-crude-exports-returned-to-pre-war-levels), compared with 17% before the war started. Another adaptation is the fact that most of the crude travelling through the strait is carried on [a shuttle fleet of very large vessels](https://kuwaittimes.com/article/50182/business/hormuz-shuttles-keep-oil-flowing-but-at-a-high-cost/) with their transponders turned off, sailing close to the Omani coastline. Their cargoes are then transferred to other vessels in the Gulf of Oman via ship-to-ship transfers.

What’s also interesting, and this is something I have yet to find a good explanation for, is the fact that despite these much higher volumes of crude shipments, which [on some days in recent weeks have exceeded those prior to the war starting](https://www.straitstimes.com/business/mid-east-oil-exports-exceeded-pre-iran-war-levels-kpler-data), the oil price has remained above $100, when, earlier in the year, when the volumes leaving the Gulf were much lower, the price was as low as $72 a barrel.

![More oil is leaving the Gulf, and Brent is back above $100](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-weekly-8oct26-brent-8a0b00a82b56-light.png)

_The 2026 low was $71.57 on 1 July, two weeks after the US–Iran memorandum of understanding. Brent settled at $104.28 on 8 October, with Gulf crude exports back at pre-war levels._

Some quite flaky explanations have been suggested for this, including the increased costs of shipping (insurance, transhipment costs, freight rates etc), which are valid up to a point but don’t provide a full answer. My guess here is that the oil supply industry is maximising an opportunity to extract anomalously high economic rent whilst it can, and that this will prevail until some normality returns or competition erodes this opportunity. In the meantime, the key question is: will these higher energy costs derail the global economy, and how will policymakers react to this challenge? _(Neil in the margin: Reuters, citing LSEG, reported in September that freight on a supertanker from the Gulf to China had topped $30 a barrel, more than a quarter of the delivered cost of the crude. Before the war it was 2–3%.)_ _(Neil in the margin: Economic rent is the return a supplier earns above what it would need to keep producing. Here, the gap between what Gulf crude costs to produce and ship and what it sells for.)_

_[Embedded media](https://oilprice.com/Energy/Crude-Oil/Kpler-Suspects-Gulf-Producers-Are-Paying-Iran-for-Safe-Passage.html)_

## A Pavlovian reaction

So far, three of the four major developed economy central banks have raised interest rates ([the Fed](https://www.cnbc.com/2026/09/16/fed-rate-decision-september-2026.html), [the ECB](https://www.ecb.europa.eu/press/pr/date/2026/html/ecb.mp260910~314e508016.en.html) and [the Bank of Japan](https://www.cnbc.com/2026/09/18/japan-raises-rates-30-year-high-yen-jgb.html)) in a classic Pavlovian reaction to the higher inflation caused by the energy price spike. Whilst this is understandable, and indeed most economists would think this is an appropriate response, I am a lot more sceptical. The central bank reaction function does to some extent depend on the prevailing monetary policy and the broader economic circumstances that predate the energy price spike, and in this case they were all different (in Japan, the US and the euro area). But the reflex that higher energy prices should automatically lead to higher interest rates is something I do not agree with.

Aside from the fact that higher rates have no effect on the causes of higher energy prices, and the fact that higher energy prices act like an additional tax on consumers (the equivalent of a fiscal policy tightening), the much-feared second-round effects that policymakers drone on about incessantly [do not automatically emerge as they seem to believe](https://www.noisecancelling.co/read/inflation-myths). Like most natural phenomena, they can only survive in the right environment. In an economy with relatively high and rising unemployment, a generally weak labour market and a competitive corporate sector, second-round effects (workers demanding higher pay rises and companies cranking up prices to protect margins) cannot thrive. Indeed, I would go so far as to say that they cannot exist in this environment. That’s why headline and, more importantly, [core inflation have both fallen in the UK in 2026](https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2026) despite the greatest energy price shock in history. (Core inflation has fallen from 3.1% to 2.6%.) Core inflation has also fallen in the US to 2.4% ([the lowest rate since 2021](https://www.bls.gov/cpi/)) and remained stable in the euro area at 2.4%. _(Neil in the margin: The knock-on effects of an energy shock: workers winning bigger pay rises to make up for higher prices, and firms raising prices further to cover higher wage bills. The first-round effect is the direct rise in fuel and energy bills.)_

![Where the second-round effects are supposed to be](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-cpi-sep26-second-round-45a2ff91d0d6-light.png)

_This is the table the hawks have to explain. If an energy shock were feeding through into wages and prices, these four numbers would be rising. All four have fallen by more than a percentage point in a year._

## Ms Greene and the wage data

Despite this, policymakers keep droning on about these second-round effects. Indeed, [Megan Greene was at it again this week](https://www.investing.com/news/economy-news/bank-of-englands-greene-says-uk-pay-outlook-worries-her-4938299) in a speech she gave in South Africa, where she said that there was a “material risk” of these effects emerging, whilst not offering any explanation as to why they had not done so yet. (She, along with other hawks on the MPC, has been confidently predicting they would emerge since the war broke out more than seven months ago.) In the same speech, Ms Greene stated that:

> There’s not a whole lot of wage disinflation happening [in the UK], and that worries me.
>
> — Megan Greene, External member of the Monetary Policy Committee

In answer to that point, I would respectfully point her at [the ONS data shown below](https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/timeseries/kaj4/lms), which indicates the precise opposite. Wage growth has more than halved since the end of 2024 and is now below 3%, which is consistent with the MPC’s 2% inflation target.

![Private sector pay growth has more than halved since December 2024](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-weekly-8oct26-private-pay-f958552d53c0-light.png)

_From 6.2% in December 2024 to 2.9% in the three months to July. Seven months into the energy shock, there is no sign of the wage response the hawks keep warning about._

_[Embedded media](https://www.youtube.com/watch?v=EQLqPXjabhk)_

In the same speech, Ms Greene also invoked the same unmeasurable nonsense so loved by academic economists, including spare capacity and inflation expectations. I wonder why members of the MPC are so confident about these things whilst at the same time erring so badly on much more important quantifiable things like [business investment](https://www.noisecancelling.co/read/the-investment-boom-the-obr-said-wouldnt-happen), which, as recently as July, the Bank said would fall this year by 1.5%, but at the end of June was growing at 5.2% year on year.

![Forecast to fall, business investment grew 5.2%](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-lord-deliver-bi-forecasts-a71e8b36c2a3-light.png)

_Even if business investment flatlines for the rest of the year, 2026 growth would be 3.6%. Both forecasts are already out by more than four percentage points._

In summary, it’s likely that as long as the “war” continues and energy prices remain elevated, there will be pressure on policymakers to “act”. My preference, and certainly in the case of the MPC, would be inaction, and my hope is that more pragmatic voices on the MPC, like those of the Governor, Andrew Bailey, and Alan Taylor, will prevail. If they don’t, a rate increase days after the Budget at the end of October is not going to go down well with the PM or his Chancellor. _(Neil in the margin: The Budget is on 28 October. The MPC announces its next decision on 5 November. Ms Greene has voted for a rise to 4% at each of the last three meetings.)_

_More on the hawks:_ [What more evidence do the hawks need?](https://www.noisecancelling.co/read/what-more-evidence-do-the-hawks-need) — A pact offered in Downing Street on Monday, a labour market that shrank again on Tuesday, and inflation on Wednesday with no second-round effects anywhere in it. The Committee votes on Thursday.

## Uncomfortable, but not unusual

A quick final mention on this subject: bond yields. [As I have been saying consistently](https://www.noisecancelling.co/read/banging-on-about-gilts), given elevated headline inflation and Fed funds at 4%, one should expect ten-year Treasuries to yield something very close to 5.3%, which they do, and ten-year gilt yields to be slightly higher than this, which they are. I accept this is uncomfortable, but it’s not unusual. As for what’s going on in [the French bond market](https://tradingeconomics.com/france/government-bond-yield/news/590139), that is unusual and does reflect market concerns about the sustainability of its fiscal policies. There is a clear difference here. _(Neil in the margin: France’s ten-year yield rose above 4.9% this week, close to its highest since 2002, and its premium over German Bunds reached 152bps on 5 October, the widest since 2011.)_

![Fed funds at 4% puts the ten-year at about 5.3%](https://r4at4qm6kmohrtvq.public.blob.vercel-storage.com/charts/chart-weekly-1oct26-fedfunds-tenyear-e61400562f0b-light.png)

_Where the Fed funds rate goes, the ten-year follows. At 4%, the long-run relationship puts the ten-year at 5.3%, about where it is._

## The headroom is there to be used

As for the UK’s fiscal headroom, my hope here is that sense has a chance of prevailing. Many commentators have been suggesting that because the Government’s fiscal headroom will have been eroded from the £24bn put in place by Rachel Reeves by the consequences of the war in the Persian Gulf, tax increases must be put in place to rebuild it. This always seemed to me to be a ridiculous argument. The contingency was put in place for unforecastable events. We’ve had one, obviously, and that’s what it’s there for. Increasing taxes now to rebuild it for another war or cataclysm seems more than a little premature, if not bordering on excessive self-flagellation. Fortunately, [it seems the Chancellor is likely to take this position too](https://finance.yahoo.com/economy/policy/articles/healey-considers-smaller-budget-headroom-105321584.html).

## The stealth tax state

Finally, to the sinister and shocking impact of stealth taxes in the UK. As [regular readers may recall](https://www.noisecancelling.co/read/markets-shrug-again-the-tax-burden-doesnt), frozen income tax personal allowances and thresholds – the most popular stealth taxes in the UK – were introduced by Rishi Sunak in 2021 in an effort to repair the fiscal damage wrought by the madness of the pandemic response. In the Budget that year, the personal income tax allowance and the higher rate threshold were frozen, and they have remained so since (the personal allowance at £12,570 and the higher rate threshold at £50,270).

Had the allowance and threshold not been frozen, [they would now be £16,070 and £64,470 respectively](https://commonslibrary.parliament.uk/research-briefings/cbp-9687/). By 2030-31, the effect of these frozen thresholds alone will yield an astonishing £55.2bn in additional tax to the Chancellor. That’s over 1.5% of GDP in that year. As shocking as that number is, these next ones are as bad. By next year, because of the frozen higher rate threshold, full-time workers on average earnings will be paying higher rate tax. The frozen personal tax allowance will also mean that those receiving the new state pension will be paying tax on that pension next year, which all logic suggests is utterly mad.

_[Chart: What the frozen thresholds would be if they had kept up with prices — Had the thresholds risen with prices, the personal allowance would be £3,500 higher and the higher rate threshold almost £14,200 higher.]_

**60%** — The effective marginal income tax rate in England between £100,000 and £125,140, before National Insurance

(As an aside, where a worker’s income exceeds £100,000, the personal allowance falls by £1 for every additional £2 of income. That means that the effective marginal rate of tax for this worker is 60% in England between £100,000 and £125,140. It’s a lunatic 67.5% in Scotland. These rates exclude National Insurance, which is an additional 2% on top of these rates.) _(Neil in the margin: The point at which the £12,570 personal allowance has been withdrawn completely: £100,000 plus twice £12,570.)_

So, to repeat myself, the effect of these two measures means that pensioners will soon be paying tax on the new state pension and full-time workers on average earnings will be paying higher rate tax. This is how obscene tax is in the UK now, but do not expect a government that cannot sanction cuts to spending and which is bumping into borrowing constraints to do anything about it. Let’s also not forget that, unlike thresholds and allowances, benefits are indexed, which means this problem gets worse as the years roll by in the absence of appropriate and tough decisions on spending and welfare.

## What to look out for next week

Next week is a busier week for macro data. In the US on Wednesday, we get [important inflation data](https://www.bls.gov/schedule/news_release/cpi.htm), which will clearly be a focus for bond markets everywhere, and jobless data on Thursday. In the UK, [various members of the MPC, including the Governor](https://www.bankofengland.co.uk/events/upcoming-events), are scheduled to give speeches during the week – don’t expect them to chime with one another – and the highlight for the UK will be [August GDP data on Thursday](https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2026). It’s also a busy week for Q3 results in the US, but it’s a lot quieter in the UK.

Given that we are scheduled to get UK GDP data, I thought I should add a few parting words in relation to what I am expecting in the remaining months of the year. Clearly, the renewed energy price spike is unwelcome and uncomfortable, but, unlike many in the economics community, I do not expect this discomfort to undermine the outlook for better growth in the UK than consensus expects. 

What’s becoming increasingly clear is that the UK economy is proving to be robust in the face of higher energy prices, and that lower saving is leading to better household consumption growth. This, alongside robust growth in investment spending across the economy, should lead to a better-than-expected full-year outcome, which I expect to be very close to 1.5%, with an exit rate higher than that. This means that the economy carries good momentum into 2027, despite slightly higher headline inflation that may breach 4% if the government mishandles intervention in the energy market to limit bill increases. 

I am still expecting CPI to trend back down to 2% by the end of 2027 and believe that there is no need to raise rates for that target to be met. A 2% growth outcome for next year seems very likely to me.