Middle East conflict reignites inflation concerns, will "Super Central Bank Week" rate decisions "hang in the balance"?

The Middle East conflict has entered its third week with no signs of easing. The Strait of Hormuz, a critical chokepoint for global energy shipping, remains at a standstill. After oil prices broke the $100 per barrel threshold for the first time since 2022, they only slightly declined due to supply concerns before rebounding. This has reignited fears of global inflation, impacting the expected global central bank rate cuts earlier this year.

In this context, industry sources estimate that about 20 central banks worldwide will hold monetary policy meetings this week, covering nearly two-thirds of the global economy. Among them, including the Federal Reserve, seven major economies will announce interest rate decisions. First, the Reserve Bank of Australia will meet on March 17, followed by the highly anticipated Federal Reserve meeting on March 18-19. On March 19, the Bank of Japan, Swiss National Bank, Bank of England, and European Central Bank will also make a series of decisions.

The Federal Reserve Faces Dual Uncertainty

Market consensus expects the Fed to keep rates unchanged this week. The combination of “negative non-farm payrolls” and “oil prices breaking $100” has created a conflict for the Fed’s dual mandate—maintaining price stability and full employment—making the short-term rate outlook uncertain. Before the rate announcement, the US government will release the February Producer Price Index (PPI), another key indicator of inflation. Meanwhile, weaker-than-expected February non-farm payrolls have raised concerns that the US labor market may cool faster than anticipated. If economic growth slows further or unemployment rises significantly, the Fed may act sooner than expected.

Amid this dual uncertainty, traders are almost unanimously betting that the Fed will hold rates steady at the upcoming meeting, with about a 40% chance of at least one rate cut later this year.

LPL Financial Chief Economist Jeffrey Roach wrote in a report: “Inflation will be affected by the war, and unemployment will be influenced by labor market turbulence. Therefore, we expect the Fed to emphasize uncertainty in these two areas of its mandate.”

RSM Chief Economist Joe Brusuelas expects the Fed to temporarily ignore volatile energy costs but admits the situation could change. “If inflation expectations start rising, the Fed will be reluctant to repeat the mistakes of the pandemic period when the Russia-Ukraine conflict triggered energy shocks,” he said.

Goldman Sachs currently predicts that the Fed will delay rate cuts until later than previously expected, forecasting a 25 basis point cut in September and December. Earlier forecasts suggested the easing cycle might start as early as June, but recent oil price surges have complicated inflation prospects.

Morgan Stanley economists recently reaffirmed their forecast of two 25 basis point rate cuts in June and September, noting that while rate cuts may be delayed, the impact of geopolitical conflicts is often short-lived, which could mean the Fed will adopt a more aggressive easing stance later this year.

Deutsche Bank also believes that even if oil prices remain high for an extended period, “given the political pressure on easing monetary policy—especially ahead of the November elections—the likelihood of the Fed cutting rates remains higher than raising them.”

Expectations for the Bank of Japan to Raise Rates as Early as April

The Bank of Japan, often considered an outlier among global central banks, is widely expected to keep its policy rate at 0.75% this week but will reaffirm its commitment to normalizing monetary policy. Many analysts believe the BOJ will continue raising rates later this year. If inflation remains stable, the policy rate could reach around 1.00% by mid-2026. Market attention will focus more on BOJ Governor Ueda Kazuo’s post-meeting comments to assess the likelihood of a rate hike in April.

A survey conducted from March 5-10 showed that over one-third (37%) of 51 economists predict the BOJ will likely raise rates again in April after holding steady this week, up from 17% two months ago.

Additionally, before the Middle East conflict escalated, overnight index swap markets priced in about a 68% chance of a rate hike in April, despite some hawkish comments from Japanese officials and economic data exceeding expectations. Traders believe that although high oil prices could harm the Japanese economy, they might also boost inflation expectations if current economic conditions align with BOJ forecasts. Japan relies almost entirely on imported oil, over 90% of which comes from the Middle East.

Ryutaro Kono, Chief Economist at Crédit Agricole Japan, stated in a survey: “If Japan’s economic outlook does not worsen, Ueda Kazuo is likely to reiterate his intention to raise rates at the post-meeting press conference. As long as the Middle East situation appears stable, the basic expectation remains for a rate hike in April.”

Beyond the Middle East situation and inflation dynamics, Prime Minister Sanae Takaichi’s views are also crucial for the BOJ, especially given her consistent support for monetary easing. Last month, her government nominated two scholars—Toichiro Asada and Ayano Sato—who advocate for re-inflating the economy, as new BOJ board members. About 80% of economists believe this appointment indicates Takaichi’s inclination to slow the pace of rate hikes. Asada will join the board in April, and Sato in June.

Meanwhile, markets also expect the BOJ to avoid signaling a too “dovish” stance that could accelerate yen depreciation. Over half of surveyed economists believe Takaichi will find it difficult to prevent the BOJ from raising rates, as doing so might lead to further yen weakening.

The renewed geopolitical tensions in the Middle East have pushed USD/JPY back toward 160, the highest since July 2024 and a key psychological level. Japanese Finance Minister Shunichi Suzuki said on March 16 that with the yen weakening sharply against the dollar and approaching 160, Japanese authorities are prepared to take decisive measures if necessary to stabilize the currency market. This level has historically been a trigger point for intervention. On that day, USD/JPY hovered around 159-160.

Tsuyoshi Ueno, Chief Economist at NLI Research Institute, commented: “Takaichi’s new appointment suggests she is not seeking to accelerate rate hikes. Therefore, the BOJ is likely to act only after carefully accumulating sufficient evidence to justify a hike. However, if the yen depreciates excessively, the BOJ might still raise rates as early as April.”

Divergence in Central Bank Policies

The market generally expects the European Central Bank to keep rates unchanged, but the Middle East conflict has nearly overturned ECB President Christine Lagarde’s previous “cautious” stance, as inflation remains a primary concern compared to the Fed’s dual mandate. Recent surges in energy prices have fueled expectations of an earlier ECB rate hike, prompting the ECB Governing Council to clarify how inflation risks have changed and how far policy is from market expectations.

In 2022, the Russia-Ukraine conflict triggered an energy crisis in Europe. At that time, the ECB drew attention for its stubborn resistance to rate hikes amid market pressure. To stabilize markets, Lagarde stated last Tuesday that the ECB will ensure that the Middle East conflict does not cause the same severe inflation shocks as the Russia-Ukraine war. “Our economic situation is different now—better and more capable of handling shocks. We will take all necessary measures to keep inflation under control and prevent a repeat of the inflation spikes of 2022 and 2023,” she said.

While the ECB will try to avoid repeating past mistakes, it is unlikely to rush into rate hikes. Lagarde also said last week: “There are too many uncertainties now. I cannot predict exactly what decision we will make at the March 18-19 policy meeting. Regardless, we will not rush—uncertainty and volatility are too high.”

Similarly, after the 2022 Russia-Ukraine conflict, the UK faced a severe energy shock. The Bank of England responded with significant rate hikes to curb rising inflation.

But this time, the situation is different. Four years ago, UK unemployment was at a 48-year low, wages were growing at the fastest pace in this century, households had pandemic savings to spend, and government stimulus supported demand. Now, unemployment is rising, vacancies are falling, economic growth has stalled, and both monetary and fiscal policies are restraining activity. Data released last Friday showed the UK economy unexpectedly contracted in January, risking falling short of the Bank of England’s 0.3% Q1 GDP growth forecast.

Simon French, Chief Economist at Panmure Gordon, said: “This is not a replay of 2022.” Economists at ING and RSM UK believe that if recent surges in oil and gas prices persist, UK inflation could rebound to more than twice the Bank’s 2% target.

Based on this, markets expect the Bank of England to hold rates steady on Thursday and possibly hint at a later rate cut. Before the Middle East conflict, the nine-member Monetary Policy Committee supported a 25 basis point cut to 3.5%, with expectations of further easing later this year. Currently, market bets on rate cuts have been completely withdrawn. Instead, traders generally expect the UK base rate to rise back to 4% by December.

Among other central banks, the Reserve Bank of Australia was the first major developed market to hike rates this year, citing persistent price pressures and excess demand amid constrained supply. Data since then has reinforced the resilience of the Australian economy, while the Middle East conflict has heightened concerns over domestic inflation. The RBA will announce its latest cash rate decision this week, with markets pricing in a high chance of a second rate hike. Attention will also be on Governor Philip Lowe’s post-meeting statement for signals on whether February marked the start of a new tightening cycle.

Markets expect the Swiss National Bank to keep rates at 0%. UBS economists note that two opposing forces are balancing each other: rising global energy prices pushing Swiss inflation higher, and a strengthening Swiss franc helping to reduce imported inflation.

With overall inflation hovering near the SNB’s 2% target, markets expect the Bank of Canada to hold its policy rate at 2.25% on Wednesday. However, similar to the UK, the upcoming employment data due Friday is a concern. Markets anticipate that February’s data may show the largest monthly decline in employment in Canada in four years.

The Riksbank is expected to keep its benchmark rate at 1.75% on Thursday, consistent with previous signals. The Swedish economy remains resilient, and inflation has fallen below the 2% target. Investors will focus on whether the Middle East conflict prompts the Riksbank to change its outlook, which currently suggests the next move will be an interest rate hike next year.

Before the Middle East conflict, market expectations were that the Brazilian Central Bank would begin easing policy. In January, policymakers indicated that a rate cut in March was their baseline scenario, supported by domestic deflationary pressures. While markets initially expected a 50 basis point cut this week, expectations have since been scaled back to 25 basis points amid ongoing Middle East tensions. Some analysts believe the cautious Brazilian Central Bank may keep rates at 15%.

Indonesia’s central bank is also expected to keep rates at 4.75% this week. This decision will require balancing between maintaining rupiah stability and concerns over rising consumer prices. While fuel subsidies could ease inflation, such measures might also widen the deficit amid fiscal worries, potentially leading to capital outflows and complicating efforts to stabilize the currency.