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(Reuters) – This is a historic week in the world of monetary policymaking. The “G4” central banks meet in the same week for the first time since December 2021, and only the second time ever, with investors clamoring for evidence of whether the Middle East oil shock could make policymakers start thinking about rate hikes.
None of these central banks – the Federal Reserve, European Central Bank, Bank of England and Bank of Japan – are expected to raise interest rates this week. But if the tone from the accompanying official statements and press conferences reflects the hawkish moves in rate futures markets, the question may soon become when, not if, the tightening will begin.
In the two weeks since the first U.S.-Israeli attacks on Iran on February 28, oil prices have soared through $100 a barrel, triggering a spike in inflation fears that have reshaped the expected 2026 policy paths for the G4 central banks.
While rate-setters are supposed to “look through” temporary spikes in energy prices, they are still smarting from their questionable call that the global inflation spike of 2021-22 would be “transitory.” They’ll be wary of making the same mistake again.
At the same time, the current energy crisis could also result in heavy hits to household spending, consumer and business confidence, and hiring. If growth slows sharply, the temptation to cut rates will be strong.
Ultimately, amid all the noise and uncertainty, rate-setters may feel it is better to sit tight and await more clarity. Pausing, they can reasonably argue, should not be interpreted as paralysis in this environment.
So let’s consider how these central banks’ expected rate paths have changed since the Middle East conflict erupted, the pressure points each faces, and what steer we can expect from them this week.
FEDERAL RESERVE
U.S. policymakers may have a bit more breathing room on the inflation front because the United States is a net energy exporter. On top of that, the dollar is appreciating and will likely benefit from war-time demand for liquidity. That should help cap U.S. inflationary pressures.
Focus will turn to the Fed’s updated Summary of Economic Projections, and whether the current median estimate of one rate cut this year and another next year is maintained. The revised “dot plot” of officials’ projected rate paths will shine further light on the range of views on the Federal Open Market Committee.
Jerome Powell also gives his penultimate press conference as Fed Chair. He said in January that no one has a rate hike as their “base case,” but that may change – not one rate cut for 2026 is fully priced into the rates futures curve, compared with more than two a few weeks ago. Could the fed funds rate be kept on hold in the current range of 3.5%-3.75% all year?
EUROPEAN CENTRAL BANK
The ECB may find itself in more of a bind, with European natural gas prices soaring 50% since the end of February. That’s nowhere near the tripling of prices seen after Russia invaded Ukraine in 2022, but it’s still a massive move.
Before the U.S.-Israeli attack on Iran, markets had shown a slight bias in favor of the ECB potentially cutting interest rates this year. Now, however, Euribor futures are pricing in roughly 50 basis points of tightening from the ECB this year, which would bring the ECB’s deposit rate up to 2.50%.
The ECB is already getting a hand from the bond market though, as soaring yields are effectively tightening financial conditions. Germany’s 2-year Schatz yield has spiked around 50 basis points since the war began, and the 10-year Bund yield is close to its highest level since 2011.
BANK OF ENGLAND
The UK is perhaps more vulnerable to spiking energy prices than the U.S. or euro zone because Britain already suffers from structurally higher inflation. Unsurprisingly, the recent shift in BoE rate expectations has been more aggressive.
The implied year-end Bank Rate is now around 4.00%, according to SONIA contracts, roughly 75 basis points higher than it was two weeks ago.
Before war broke out, traders were penciling in two quarter-point rate cuts this year. That’s now flipped to one hike. Meanwhile, the two-year gilt yield has shot up 65 bps, around 20 bps more than comparable U.S. and euro zone yields.
All this suggests the BoE will drop its easing bias on Thursday.
BANK OF JAPAN
BOJ officials may be in the tightest spot. Japan imports around 90% of its energy, with the majority of that coming from the Middle East, so the inflationary risks are enormous. And that’s on top of all the issues the BOJ was juggling before the war began: a weak and volatile exchange rate, liquidity concerns at the long end of the curve, and record fiscal stimulus coming down the pike.
The yen is a major concern. It’s currently at levels which, in recent years, have prompted aggressive intervention from Tokyo to prevent further depreciation. But would intervention now be justified if the economic ‘fundamentals’ warrant a weaker yen?
Put it all together and inflation risks are flashing red, but BOJ officials are rightly wary about raising rates too quickly for fear of derailing the economy’s recovery. They may be doubly reluctant to do so, as the fog of war and uncertainty thickens.
(The opinions expressed here are those of Jamie McGeever, a columnist for Reuters)
By Jamie McGeever; Editing by Marguerita Choy
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