World’s Top Central Banks Are About to Confront Fresh Inflation Threat as War Jolts Oil

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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.

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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.

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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.

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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. 

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The BOE faces the “classic example of a stagflation problem,” according to Emma Moriarty, portfolio manager CG Asset Management.

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“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.”

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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.

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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.

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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.

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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.

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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.

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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. 

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“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.”

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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.

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“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.”

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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.