The European Central Bank (ECB), US Federal Reserve, Bank of England and Bank of Japan are widely expected by economists to keep their key interest rates on hold this week as they await clues for how the Iran war will affect inflation.
However, comments on the outlook for consumer prices and monetary policy will be closely monitored by financial markets, as key committees of four of the world’s most influential central banks hold their first rate-setting meetings since the Gulf crisis erupted on February 28th.
The Bank of International Settlements (BIS), dubbed the bank of central banks, this week urged interest rate-setters globally not to rush to respond to a spike in energy prices.
This month’s 40 per cent jump in oil prices and near 60 per cent surge in wholesale gas prices have evoked comparisons to 2022, when Russia’s invasion of Ukraine and the post-Covid reopening of the global economy sent inflation rates soaring.
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Central banks – particularly the ECB – were seen as slow to respond to that inflation spike with rate increases.
Financial markets are now betting on a quicker response from central banks to signs of inflation creeping through economies.
Money markets have now fully priced in a quarter of a percentage point ECB rate increase by July, from 2 per cent, currently, and an 85 per cent chance of a second hike by the year end. They have also halved the number of Fed rate cuts expected this year to one.
“If it’s a supply shock, and certainly if it’s a temporary one, these are the textbook examples where you should look through and not react with monetary policy,” the BIS’s top economic adviser, Hyun Song Shin, said.
“It really depends on how long the conflict lasts and how long the rise in the oil price will be sustained.”
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While staff at the ECB are set to outline their latest quarterly inflation and other economic forecasts at the bank’s governing council gathering on Wednesday and Thursday, HSBC economist Fabio Baldoni said that February 25th likely marked the cut-off date for data and technical assumptions for the report. This predates the Iran war.
“However, it is likely the ECB staff will offer scenarios – at least internally to the [governing council] – based on different energy prices,” Baldoni said in a note to clients. “With oil and gas prices at current levels, inflation could be around 3 per cent by the second half of this year.”
The ECB targets inflation of about 2 per cent. Euro zone headline inflation was running at 1.9 per cent in February, down sharply from a peak of 10.6 per cent in late 2022. – Additional reporting, Reuters
