Super Central Bank Week Outlook: Pause, But Not Calm

This week, the global financial markets are experiencing a true “Super Central Bank Week” — major central banks such as the Federal Reserve, Bank of Japan, and European Central Bank will hold a series of monetary policy meetings. On the eve of these meetings, an unexpected geopolitical storm has completely rewritten the market’s calm narrative: the escalation of the US-Iran conflict has triggered a surge in international oil prices, and the clouds of stagflation are once again overshadowing the global economy.

Analysts suggest that this week, the Federal Reserve and the Bank of Japan are most likely to keep interest rates unchanged. The Fed faces a dual dilemma of “weak employment” and “high oil prices,” while the Bank of Japan, due to its heavy reliance on energy imports, is caught in deeper policy hesitation.

Across the Pacific, behind the “pause” of these two major central banks are entirely different economic narratives. For the Fed, if the conflict is resolved within a month and oil prices fall back after spiking, inflation risks will be manageable, and there is still room for rate cuts this year. However, if the conflict becomes prolonged, the Fed will face a deeper dilemma. For the Bank of Japan, the surge in oil prices further reinforces imported inflation driven by yen depreciation, and the bank may restart rate hikes as early as the April meeting.

US Economy Narrative Shifts from “Soft Landing” to “Stagflation”

The market widely expects the Federal Reserve to keep the federal funds rate in the 3.50%-3.75% range this week, and to hold steady throughout the first half of the year. Behind this consensus is the intense conflict between the Fed’s dual mandates — full employment and price stability.

Recent data show that in February, US non-farm payrolls unexpectedly decreased by 92,000, and the unemployment rate rose to 4.4%. Data for December last year and January this year were revised downward by a total of 69,000. The unexpected slowdown in the labor market should have provided ample reason for rate cuts. However, the opposite is true: since the escalation of tensions with Iran, international oil prices have soared, with Brent crude futures rising from around $72 per barrel at the end of February to over $100. According to Morgan Stanley, a 10% increase in oil prices directly raises overall US inflation by about 0.3 percentage points, and current actual increases have far exceeded this level.

Bai Xue, Senior Vice President of Research and Development at Western Securities, told Jiemian News that the core of market trading is shifting from the prosperity of artificial intelligence and expectations of a “soft landing” to pricing geopolitical risks and stagflation threats.

“The direct trigger for this shift is the energy supply shock caused by escalating Middle East geopolitical conflicts. The surge in oil prices not only directly raises short-term inflation expectations but also raises concerns that this will, through cost transmission mechanisms, exert substantial pressure on the US economic growth outlook,” Bai said.

Without considering the disruptions caused by the US-Iran conflict and rising oil prices, the inflation trend in the US in 2026 would mainly be influenced by tariffs and endogenous demand. In a baseline scenario without external oil shocks, US inflation in 2026 would lack strong upward or downward momentum, maintaining a moderate fluctuation pattern. However, the Middle East conflict has broken this pattern.

Analysts say that the impact of rising oil prices on US inflation occurs on two levels: first, directly increasing energy-related components, which quickly reflect in the overall CPI; second, gradually permeating into core inflation through cost transmission, affecting the core Personal Consumption Expenditures Price Index (PCE), which is currently running close to 3% year-over-year. If oil prices remain high and this transmits into core inflation, the Fed will face a dilemma between controlling inflation and maintaining growth.

Although it may be premature to say the US economy has entered stagflation, the policy room for the Fed has significantly narrowed amid inflation rebound and slowing growth. The market generally expects only 1-2 rate cuts this year, with the first cut not until September, contrasting sharply with pre-conflict expectations of two cuts within the year and the first as early as June.

Morgan Stanley believes that if oil prices do not fall back to pre-conflict levels, the first rate cut this year could be delayed until the end of the year. Ernst & Young notes that supply shocks are difficult to handle, as they simultaneously push up inflation and suppress output, making it more likely that the Fed will keep rates unchanged for “a long time.” The Chicago Mercantile Exchange’s “FedWatch Tool” shows that the probability of rate cuts in each of the remaining seven meetings this year does not exceed 50%.

Bai Xue predicts that in the first half of the year, the Fed will adopt a data-dependent stance, and in the second half, it may cut rates 1-2 times. The specific pace and magnitude will depend on geopolitical developments and economic recovery. She emphasizes that short-term geopolitical disturbances do not change the overall monetary policy direction, as the recent inflation rebound is mainly driven by oil price increases caused by geopolitical conflicts — an exogenous shock rather than demand-driven. Moreover, the core inflation excluding food and energy has increased relatively mildly. While rising oil prices boost inflation, they also suppress US economic growth.

Western Securities overseas analyst Zhang Ze’en expressed a more optimistic view, telling Jiemian News that the conflict is likely to end in about a month, around late March to early April. Once the conflict ends, the Fed will need to reassess its impact on the economy, and the first rate cut could occur in April.

Japan’s First Rate Cut of the Year May Come Earlier

Unlike most central banks worldwide, the Bank of Japan is currently in a rate-hiking cycle. Although analysts believe the BOJ will keep rates steady at the March meeting, the depreciation of the yen driven by imported inflation pressures and resilient core inflation may prompt an earlier rate hike within the year.

Several sources told foreign media that the BOJ has largely ruled out a rate hike in March, needing time to carefully assess the impact of Middle East conflicts on the economy and prices. BOJ Vice Governor Masayoshi Amamiya recently stated that the Middle East situation could influence Japan’s economy and inflation, but it is too early to predict specific effects, and the BOJ will closely monitor developments.

Official data show that Japan’s self-sufficiency rate for crude oil is less than 1%, with over 92% of its oil imports coming from the Middle East, and more than 80% of transportation routes passing through the Strait of Hormuz. This means that any disturbance in the Strait of Hormuz will directly affect Japan’s energy costs and inflation levels. This is also one of the reasons why Japan’s stock market fell among the worst globally after the outbreak of the US-Iran conflict. On March 17, the Nikkei 225 closed at 53,700.39, about 9% lower than the last trading day before the conflict.

On the other hand, like the US, Japan also needs to balance between stabilizing growth and controlling inflation. According to calculations by the Japan Research Institute, a prolonged blockade of the Strait of Hormuz could reduce Japan’s annual GDP by 3%. Nomura Research Institute data shows that every $10 increase in international oil prices per barrel raises Japan’s annual energy import costs by 1.3 trillion yen, directly increasing electricity, industrial, and logistics costs, and posing risks of production cuts in key industries like automotive, electronics, and chemicals.

Over the past years, the BOJ has used Yield Curve Control (YCC) to set a target range for 10-year government bond yields and maintained policy rates in negative territory to stimulate demand and raise inflation. Since the pandemic in 2020, Japan’s inflation has gradually risen, and a benign wage-price cycle has begun to form. In March 2024, the BOJ officially announced the end of YCC and entered a rate hike cycle. So far, the BOJ has raised rates four times, with a total increase of 85 basis points to 0.75%, the highest since September 1995.

The recent escalation of tensions with Iran, through crude oil prices, has exerted an unexpectedly strong upward pressure on Japan’s inflation, possibly prompting the government to accelerate fiscal subsidies and tax cuts to stabilize prices.

Zhang Ze’en said that the BOJ’s rate hike decisions are influenced by domestic inflation levels, economic conditions, and yen depreciation pressures. Yen depreciation and inflation stickiness are the core drivers of rate hikes, while uncertainties in economic outlook continue to constrain the pace and scale of policy tightening, prompting the central bank to remain cautious.

He further noted that the current high level of USD/JPY exchange rate, persistent Japanese interest rate differentials, and risk aversion triggered by Middle East conflicts have further weakened the yen. As an economy highly dependent on energy and resource imports, yen depreciation directly raises import costs for crude oil, grains, and other commodities, making imported inflation difficult to quickly ease — the surge in oil prices due to Middle East tensions has already significantly increased Japan’s crude oil import costs, potentially offsetting half of the government’s price stabilization measures.

“At the same time, domestic inflation in Japan remains sticky. Although the core CPI reached 2% in January, aligning with the policy rate target, as the ‘spring wage offensive’ progresses, the wage-price transmission cycle continues. Additionally, the risk of capital outflows caused by yen depreciation requires moderate rate hikes to narrow interest rate differentials and stabilize exchange rate expectations, avoiding a vicious cycle of ‘depreciation — inflation — capital flight’,” Zhang said. He expects the BOJ to bring forward its first rate hike from June to April this year.

Moody’s, in a report, expects the BOJ to keep rates steady this week but possibly raise them to 1% by mid-year. Moody’s notes that a further weakening of the yen could prompt the BOJ to “preemptively hike rates” later this year, but sluggish wage growth and economic data make aggressive hikes above 1% unlikely.

Since April last year, the yen has continued to weaken against the dollar, accelerating after the conflict erupted. As of press time, USD/JPY has fluctuated above 158. The Japanese Ministry of Finance has stated that, with the yen’s sharp decline approaching the 160 level, it will take decisive measures if necessary to address exchange rate fluctuations.