A second major energy price shock in five years is influencing global monetary policy decisions, with key central banks scheduled to hold interest rate meetings this week. However, most are expected to maintain current rates.
Frequent social media posts by former U.S. President Donald Trump continue to unsettle energy markets, making it difficult for policymakers to reliably forecast inflation trends. The Federal Reserve, European Central Bank, Bank of Japan, Bank of Canada, and Bank of England will all announce interest rate decisions this week against a backdrop of geopolitical risks from Middle East conflicts and significant volatility in commodity markets.
According to analysis, Tomasz Wieladek, Chief European Macro Strategist at T. Rowe Price, stated, "Given the uncertainty in the Gulf region and unclear transmission mechanisms of energy shocks to growth and inflation, the correct approach for central banks currently is to wait and see." Market expectations for rate hikes this week are extremely low, yet inflation risks are accumulating.
A major concern looming over these meetings is the historical lesson from the significant inflation surge between 2021 and 2022, when many central banks were criticized for acting too slowly. Policymakers are acutely aware that misjudging the situation again would come at a heavy cost.
Trump's posts are reshaping oil market behavior. A notable feature of the current energy market turbulence is the direct impact of Trump's social media activity on oil prices. Sebastian Barrack, Head of Commodities at hedge fund Citadel, noted recently that Trump's posts during the Iran conflict have fundamentally altered how oil markets function. Traders often struggle to respond to the sharp volatility triggered by his frequent posts and the Iranian regime's reactions.
Faced with this highly uncertain environment, central banks have adjusted their decision-making frameworks—shifting focus away from single central forecasts toward greater emphasis on scenario analysis, incorporating various potential outcomes of the Middle East conflict.
Jens Larsen, a former Bank of England official now with Eurasia Group, pointed out, "This is a significant challenge for central bank officials accustomed to thinking in terms of marginal pricing and labor market evolution."
Among major Western central banks, the European Central Bank is seen as being in a relatively advantageous position. Katharine Neiss, Chief European Economist at PGIM Fixed Income, noted that the ECB is "the only one to have genuinely brought inflation back to its 2% target," granting it greater policy flexibility.
Financial markets currently price in two rate hikes by the ECB this year from the current 2% level. However, ECB Chief Economist Philip Lane stated last week that the institution is in no rush to make judgments. "Until we have a clearer picture of how long this war will last, it is difficult to assess whether this is a temporary phase or a more significant shock to the European economy," he remarked during a panel discussion in Frankfurt.
Jens Eisenschmidt, Economist at Morgan Stanley, believes the earliest the ECB could "properly assess whether action is needed" would be June, or possibly even later.
The Federal Reserve is set to vote on Wednesday, with an almost certain outcome of maintaining the benchmark rate in the 3.5% to 3.75% range. The Fed has put rate cut prospects on hold, awaiting clearer signals on whether the Iran conflict could hinder its ability to achieve the 2% inflation target or further weaken the already softening U.S. labor market. The U.S. PCE inflation rate stood at 2.8% year-on-year in February, still above target.
However, some officials have begun warning about inflation risks. Fed Governor Chris Waller cautioned this month that a series of price shocks, stemming not only from the war but also from Trump's trade policies, threaten to erode public confidence in the Fed's ability to control inflation. Waller indicated that the longer energy prices remain elevated, the greater the likelihood that high inflation becomes embedded in the U.S. economy, leading households and businesses to expect persistent price pressures.
Joe Lavorgna, Chief Economist for the Americas at Sumitomo Mitsui Banking Corporation and a former advisor to the U.S. Treasury Secretary, commented, "We are entering another supply shock of uncertain duration, while U.S. inflation remains well above target."
Expectations for rate hikes by the Bank of Japan and the Bank of England have also cooled significantly. Investors had previously anticipated a rate hike by the BOJ this week from the current level of around 0.75%, but market pricing now suggests a very low probability. Uncertainty from the Iran conflict, combined with Japan's particular vulnerability as a heavy importer of energy and industrial raw materials, makes the timing of a rate hike increasingly difficult to gauge.
Recent remarks by BOJ Governor Kazuo Ueda contained no hints of an April rate hike, and officials have signaled that the bank no longer seeks to surprise markets with its actions. Go Kurihara, Economist at UBS, expects the BOJ's decision on Tuesday to be accompanied by a significant upward revision to inflation forecasts and a downward revision to economic outlook.
Similarly, the Bank of England had seemed to hint at a possible near-term rate hike from 3.75% in March, but after Governor Andrew Bailey signaled that investors had overreacted, traders now assign a very low probability to such a move.
Wieladek summarized the common sentiment among central banks: "They want to know if we are heading toward a 2022-like scenario—where inflation significantly overshoots expectations. But with just one month of data, they simply cannot make that judgment."
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