World’s Top Central Banks Are About to Confront Fresh Inflation Threat as War Jolts Oil
(Bloomberg) — The world’s top central banks convene this week facing a renewed inflation threat from the war in Iran and the possibility that they’ll be forced to delay interest-rate cuts and in some cases consider hikes.
Changes aren’t imminent yet: The Federal Reserve, the European Central Bank and the Bank of England are all expected to keep borrowing costs steady as they assess how much surging energy costs will feed through to consumer prices and growth.
But for them and the other 18 central banks that are about to set policy — overseeing about two-thirds of the global economy in total — the tone will turn more cautious as they acknowledge the risk of another inflation shock.
Much hinges on how long the conflict lasts — something markets are struggling to gauge. Investors wary of stagflation have been whipsawed by oil-price swings and uncertainty over Donald Trump’s next move, raising questions about how quickly central bankers would react to fresh price pressures.
What’s clear is that policymakers around the globe — still counting the cost of US tariffs and grappling with a fragmenting geopolitical landscape — are reluctantly preparing to step back in should events in the Middle East reignite consumer prices, derail economic growth or hijack their currencies.
“Central banks can set interest rates — they can’t reopen the Strait of Hormuz,” said Tom Orlik, Bloomberg Economics’ chief economist. “Expect Powell, Lagarde, Bailey & Co to stay on hold, signal vigilance, and hope the Iran war ends before it lands them with another inflation problem they’re ill equipped to solve.”
It’s not just the Iran situation that’s prompting the higher state of alert. Memories of the last inflation shock, when prices increases reached double digits in some major economies after Russia invaded Ukraine in 2022, are still painfully fresh.
Like then, it’s tough to estimate the duration of the fighting.
Trump has flip-flopped from saying the war could end “very soon” to claiming the US has “plenty of time” as it pounds targets from the skies. Iran’s new Supreme Leader Mojtaba Khamenei, meanwhile, has vowed to keep the Strait of Hormuz — a choke point for energy shipments — effectively closed.
For now, reductions in borrowing costs remain on the Fed’s horizon — albeit not this month — as inflation risks emanating from the Middle East are eclipsed by cracks appearing in the US labor market.
While markets no longer fully price a cut in 2026, they’re still leaning toward easing — making the US the outlier among its Group of Seven peers.
Indeed, as discontent over rising gasoline prices builds before mid-term elections, Trump has renewed his call for rate cuts — even demanding an interim move.
Morgan Stanley economists affirmed their call for quarter-point decreases in June and September, saying a delay is possible but could mean the Fed has to act more forcefully down the line.
Even if oil prices remain lofty for an extended period, “given the political pressure for loose monetary policy, especially ahead of the November elections, rate cuts would still be more likely than rate hikes,” said Christoph Balz, an economist at Commerzbank.
It’s a different story in Europe, where despite the risks to growth the focus is firmly on inflation and expectations of further loosening have been all but extinguished.
In the UK, which saw price gains top 11% in 2022, the odds of a March cut were at almost 80% shortly before the US and Israel attacked Iran. Now, policymakers are expected to hold, and while economists including those at Goldman Sachs still see reductions later this year, traders have started to price an increase.
The BOE faces the “classic example of a stagflation problem,” according to Emma Moriarty, portfolio manager CG Asset Management.
“On the one hand, the BOE needs to look responsive and make sure that inflation expectations are anchored,” she told Bloomberg Television on Friday. On the other hand, there’s a real risk that raising rates “makes a weak demand problem even worse.”
Growth is a little sturdier in the 21-nation euro zone, which finds itself far better placed to handle an upswing in inflation than last time around. Officials are expected to hold borrowing costs steady on Thursday, though some have hinted at movement ahead.
The experience of the 2022 “could make the ECB more aware of the risk of expectations getting de-anchored and quicker to hike rates if energy pressures are sustained,” said Fabio Balboni, HSBC’s senior euro-zone economist.
Markets are convinced the ECB will have to act, betting on one or two increases this year. Only 7% of respondents in a Bloomberg poll of analysts, however, predict any tightening.
The odds are stronger in Japan, where price growth has exceeded the central bank’s 2% target for four straight years. After probably standing pat on Thursday, an April increase isn’t ruled out, people familiar with the matter said this month.
Japan, like much of Asia, relies heavily on Middle East crude imports, with more than 80% of shipments traveling through the Strait of Hormuz headed east. That means a lengthy spell of high oil prices could prove costly for both inflation and economic expansion.
A one-month blockage would drive Brent toward $105 a barrel, while a three-month shutdown could push peak prices near $164, according to a model from Bhargavi Sakthivel and Ziad Daoud at Bloomberg Economics.
“Hormuz will determine how things proceed,” said Carsten Klude, chief economist at M.M. Warburg & Co. “The bottleneck is real. Anyone who ignores it is ignoring the most important transmission channel of this crisis.”
There’s likely to be a sprinkling of immediate action on rates this week. Economists see the fallout from Iran prompting Australia to bring forward a hike anticipated for May to Tuesday — continuing a tightening cycle that kicked off in February.
“Central banks will remain hawkish so long as the threat of the war’s inflationary implications persists,” said Thierry Wizman, global FX and rates strategist at Macquarie Group. “We would expect that this more ‘hawkish’ disposition persists even after hostilities end.”
Elsewhere, it looks like Brazil will deliver a cut on Wednesday, spurred by sputtering growth late last year and borrowing costs that are near a two-decade high. Even so, easing may now proceed only gradually and markets are split on the size of this week’s cut after an official said the central bank “can’t ignore” the consequences of the war.
Those two examples underscore how the Iran war is catching economies in different stages of their cycles, requiring varying responses that can have material implications for currencies.
Safe-haven flows are already driving the dollar and Switzerland’s franc higher, with pressure on the latter likely to nudge the Swiss National Bank to toughen its language on interventions.
BOJ officials face the opposite problem as acknowledging economic perils risks further weakening the yen. The currency is already hovering close to 160 a dollar — a level that prompted intervention in 2024.
The exchange rate also is an issue in Indonesia, where fuel subsidies will probably cushion faster inflation but risk bloating the deficit amid heightened fiscal concerns. That could spur more capital outflows and undermine central-bank efforts to maintain a stable currency.
With the war sparking such a range of challenges, the remedies officials prescribe will also differ across economies and continents. Lacking clarity on when the fighting will end, the main thing is to stay nimble, according to the International Monetary Fund.
“If the new conflict proves prolonged, it has clear and obvious potential to affect market sentiment, growth and inflation, placing new demands on policymakers,” Managing Director Kristalina Georgieva said. “In this new global environment, think of the unthinkable and prepare for it.”
–With assistance from Kira Zavyalova, Swati Pandey, Yian Lee, Toru Fujioka, Malcolm Scott, Lizzy Burden, Tom Mackenzie, James Hirai and Bastian Benrath-Wright.
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