The Bank of England is monitoring the Middle East crisis amid fears that a worsening conflict between Iran and Israel will make it impossible to stabilise oil prices and leave the global economy vulnerable to a 1970s-style energy shock. Andrew Bailey, the Bank’s governor, said he was watching developments “extremely closely” and that there were limits to what could be done to prevent the cost of crude rising if things “got really bad”. In a wide-ranging interview with the Guardian, Bailey held out the prospect of the Bank becoming a “bit more aggressive” in cutting interest rates provided the news on inflation continued to be good. Shortly after this interview was published online, the pound fell by ¢1.5 to a three-week low as traders reacted to the hints of a more activist approach to reducing the cost of borrowing. Bailey also hit back at claims by the former prime minister Liz Truss that the Bank of England was part of a “deep state” that had set out to thwart her plans. Truss’s problems were of her own making, the governor said. Bailey was speaking from his office in Threadneedle Street after this week’s Israeli invasion of southern Lebanon and Iran’s launch of ballistic missiles in response. Oil prices rose by 3% amid concerns that a deepening conflict might disrupt supplies of crude from the Middle East. “Geopolitical concerns are very serious,” Bailey said. “It’s tragic what’s going on. There are obviously stresses and the real issue then is how they might interact with some still quite stretched markets in places.” Bailey said that in the year since the Hamas attack on Israel there had not been a big rise in oil prices of the sort seen in the past. “From the point of view of monetary policy, it’s a big help we haven’t had to deal with a big increase in the oil price. But obviously we’ve had that experience in the past, and in the 1970s, the oil price was a big part of the story. “Obviously, we keep watching it. We watch it extremely closely to see the impact of the latest news. But … my sense from all the conversations I have with counterparts in the region, is that there is, for the moment, a strong commitment to keep the market stable. “There’s also recognition there’s a point beyond which that control could break down if things got really bad. You have to continuously watch this thing, because it could go wrong.” Bailey said the economy has proved more resilient than he feared two years ago, or even a year ago. “I think the economy has come through the shocks of the last five years better than many of us feared. So there’s a base there to develop. “The government is right to focus on how to encourage capital investment. There is a clear need for it in terms of infrastructure. We’ve got at least three very big structural issues out there. One is the ageing population, which obviously we’re not alone in that one. Two is the demands for increase in defence spending. And the third one is dealing with climate change.” Bailey became governor in March 2020, just as the Covid pandemic was hitting. He said for much of the period since then the Bank had been engaged in “crisis management” but he hoped the second half of his eight-year term would be calmer. Inflation as measured by the consumer prices index currently stands at 2.2% – just above its official 2% target, but Bailey said he was encouraged by the fact that cost of living pressures had not been as persistent as the Bank thought they might be. He said if the news on inflation continued to be good there was a chance of the Bank becoming more “a bit more activist” in its approach to cutting interest rates, now at 5%. He strongly defended the way the Bank responded to the pandemic, global supply-chain bottlenecks and the invasion of Ukraine, rejecting criticism that he and his colleagues left stimulus in place for too long, resulting in the highest inflation in four decades and the need to raise interest rates from 0.1% to 5.25% in 14 consecutive jumps. “I sometimes read some of this commentary and think, do you remember what happened in 2020, with the economy? I mean, we did drop off a cliff. Anybody who says it was the wrong thing to do to come in and support the economy as we and others did – that’s just not realistic.” If the Bank had not acted at it did, Britain would have been plunged into a second Great Depression, he added. Among the governor’s critics are Truss, who said Bailey was part of the “deep state” responsible for undermining her short-lived premiership. “I don’t know what she means by that,” Bailey said, adding he had never met her. Truss’s problems, he said, were the result of her chancellor Kwasi Kwarteng’s mini budget, which led to a sharp increase in market interest rates and potentially massive losses for UK pension funds before the Bank stepped in to help. “I remember Liz Truss saying at the time: ‘It’s a financial stability issue, it’s the Bank of England’s job to deal with it.’ We did. We came in and we used our intervention tools and dealt with it. But it is a bit ironic for somebody who is so critical of regulators to then come out and say the problem is that the Bank of England wasn’t regulating.” Bailey said accusations that the Bank was part of a deep state made his job as governor more difficult. “I’ll say this about some of the things that are said about the ‘deep state’: it’s not easy running public institutions these days. I can tell you. “People say there’s somehow an agenda for this or an agenda for that, and the agenda really is that we’re trying to run an institution to its maximum effectiveness.”