Central Banks on High Alert: The Ripple Effects of the Iran War
Central banks from Washington to London to Jakarta are poised to deliver their initial evaluations of the economic repercussions following more than two weeks of conflict between the US and Iran. Decisions in the coming week involving every member of the Group of Seven and eight of the world’s 10 most-traded currency jurisdictions are expected to reassure investors that the looming threat of a new inflation shock is significant enough to warrant increased caution. Interest-rate bets that fully anticipated easing in the US have diminished, while potential hikes in the UK and euro zone later in the year are now being factored in. Such shifts will compel policymakers to clarify the degree to which these wagers are warranted. What Economics States: “For the Fed, much depends on how the conflict evolves.” If the war concludes swiftly, we anticipate a slight increase in the unemployment rate and a decrease in core inflation, paving the way for rate cuts of approximately 100 basis points this year. “If the conflict drags on, keeping energy prices high and pushing inflation expectations higher, the calculus becomes far more difficult.” The Iran war marks the second occasion in slightly more than a year that US President Donald Trump’s policies have significantly impacted global central banks, following his so-called Liberation Day tariffs in April, which aimed to reshape world trade. The experience of uncertainty and risk will keep policymakers on edge in the coming months. The Fed is widely expected to do precisely what was anticipated weeks prior to their March 17-18 policy gathering: maintain rates at their current level. However, in recent days, the narrative surrounding that hold — suggesting it may comfortably endure for months — has been shattered by renewed tremors in the labor market and a war in the Middle East that has caused oil prices to surge. The interplay creates tension between the Fed’s dual mandates, obscuring the near-term outlook for interest rates.
Market pricing indicates that money markets suggest a 90% probability of a quarter-point rate cut in 2026, with expectations leaning towards this occurring from September onwards. On Wednesday morning, as Fed officials continue their discussions, the government is set to unveil another component of the US inflation puzzle with the release of the February producer price index. Economists observe a more modest rise in wholesale cost measures compared to January, when there was a significant surge in service prices. In the upcoming week, additional economic data will be released, including February’s industrial production figures and January’s new-home sales statistics. Officials in Frankfurt are expected to maintain the deposit rate at its current level on Thursday. However, the crisis in the Middle East has nearly uprooted ECB policy from the “good place” that President Christine Lagarde and her colleagues once asserted they occupied. The surge in energy prices, which has ignited speculation about rate increases, places the responsibility on the Governing Council to clarify how inflation risks have evolved, as well as to provide insights into their proximity to fulfilling those market anticipations. Investors have drawn comparisons between the ongoing energy shock and the crisis of 2022 that ensued after Russia’s invasion of Ukraine, during which the ECB was notable for its unwavering stance against market demands for increased rates. However, although the central bank will endeavor to prevent a recurrence of its previous errors, it is improbable that it will hastily implement a rate increase.
Market pricing: Following a recent year-long hold, traders are now wagering that the ECB will implement at least one rate increase in 2026. From July onwards, one quarter-point hike is fully priced in, and swaps indicate a 70% probability of a second hike by the end of the year. The BOJ is anticipated to maintain its benchmark rate on Thursday, while reassuring markets of its commitment to policy normalisation. Governor Kazuo Ueda is expected to stress the importance of closely observing developments due to the nation’s significant dependence on oil imports from the Middle East. Although prolonged elevated crude prices may negatively impact Japan’s economy, they would simultaneously contribute to inflationary pressures. Policymakers must also evaluate the potential risk of further weakening the yen if they adopt an excessively dovish stance. The currency on Friday fell to its lowest level against the dollar since 2024. Traders will analyze the BOJ’s statement and Ueda’s remarks for insights, as investors closely assess the likelihood of a rate hike by April. According to sources familiar with the matter, the possibility of a move has not been ruled out. Market pricing indicates that traders are leaning towards a single quarter-point hike by July, with a 90% probability assigned to a subsequent increase by December. A decision that seemed merely “50-50” regarding a potential cut last month, as noted by Governor Andrew Bailey, is now strongly leaning toward maintaining unchanged rates this Thursday.
Economists believe that inflation may rise to over twice the central bank’s 2% target if the recent increase in oil and gas prices persists. Officials are compelled to shift their focus toward monitoring consumer prices, even as indications of faltering growth emerged prior to the recent energy crisis. Data released on Friday indicated that the UK economy unexpectedly did not grow in January, posing a risk of falling short of the BOE’s first-quarter projection for gross domestic product to increase by 0.3%. Market pricing indicates that money markets suggest a 60% probability of the BOE increasing rates in 2026, with the most likely timing being from July onwards. Prior to the commencement of airstrikes by the US and Israel on Iran, and the subsequent increase in oil prices, the market had fully accounted for two quarter-point cuts by the end of the year. The inflation data for February, set to be released two days prior to the Bank of Canada’s decision on Wednesday, will offer policymakers a crucial insight into price pressures, especially in light of the recent Middle East conflict that has driven oil prices upward. Additionally, Friday’s data revealed that the economy experienced a greater loss of jobs in February than in any month over the last four years. As headline inflation remains close to the central bank’s 2% target, markets anticipate that policymakers will maintain their policy rate at 2.25% on Wednesday. Attention will be focused on Governor Tiff Macklem’s news conference for insights into how the Iran crisis might influence the economic outlook.
Market pricing indicates that a quarter-point rate hike in October is fully accounted for by money markets. The central bank’s determination to limit gains that propelled the franc to decade highs against the euro will be closely examined at its first quarterly decision of the year on Thursday, following Swiss policymakers’ departure from their typical silence to disclose a heightened readiness for intervention. Any change in language regarding foreign exchange will be significant, yet economists agree that the rate will remain at zero. This consensus indicates that they believe the current situation does not necessitate the more severe and economically detrimental measure of reverting to negative borrowing costs. The franc remains a central concern for SNB officials, as its appreciation exerts pressure on already weak inflation through reduced import costs. Nonetheless, the elevated oil price may lead to some price growth, alleviating the urgency for them to take action. Market pricing indicates that swaps suggest an 85% likelihood of a rate hike occurring in 2026, with pricing effective from September onwards. The Swedish central bank is anticipated to maintain its benchmark rate at 1.75% on Thursday, consistent with earlier indications, as the economy shows signs of strengthening while inflation dips below the 2% target. Attention will be drawn to new economic forecasts and a revised rate path as investors seek to understand if the turbulence in the Middle East has influenced policymakers’ perspective on the anticipated rate hike next year. Market pricing indicates that traders assign a 50% chance to a 25-basis-point hike starting in June.
On Tuesday, Australian policymakers are expected to determine the cash rate, which currently stands at 3.85%, as markets anticipate a strong possibility of a second consecutive increase. The RBA last month became the first major developed-market central bank this year to raise borrowing costs, citing “stubborn price pressures and excess demand in a supply-constrained economy.” Since then, data have strengthened the image of resilience, while the Iran war has intensified worries regarding domestic price pressures. Officials face the challenging decision of determining whether an additional hike would enhance credibility or potentially tighten conditions amid a backdrop of growing global uncertainty. Markets will closely examine the post-meeting statement and Governor Michele Bullock’s press conference for indications on whether February signaled the beginning of a new tightening phase. Market pricing indicates that money markets are anticipating three additional rate hikes from the RBA in 2026, commencing on Tuesday. Before the outbreak of war in Iran, Brazil’s central bank appeared poised to initiate an easing campaign. In January, policymakers indicated that a cut in March was their base case, and the trends of disinflation and reduced expectations provided them with considerable flexibility. Now, instead of the half-point cut that many analysts had anticipated, the consensus now expects a quarter-point reduction, and some observers of Brazil can also see the cautious board giving some consideration to holding yet again at 15%.
The central bank in Jakarta is anticipated to maintain its rate at 4.75% on Tuesday, a choice that will compel officials to weigh rupiah stability against fresh concerns regarding consumer prices. Although fuel subsidies may provide some relief against rapid inflation, these actions carry the potential to exacerbate the deficit in light of increasing fiscal worries. This may lead to increased capital outflows and jeopardize officials’ attempts to uphold a stable currency. On Friday, officials from the Bank of Russia will consider whether the recent rise in inflation, following an increase in the value-added tax rate, is subsiding enough to permit a seventh consecutive reduction in its key interest rate. Policymakers reduced the rate by 50 basis points at each of the last three meetings. Their decision is set to occur right before the release of consumer-price data for February.
