Global central banks are facing significant pressure due to an oil price shock triggered by the war in the Middle East, with investors now expecting rate-setters to increase borrowing costs to combat rising inflation [1]. Julian Howard, chief multi-asset investment strategist at GAM Investments, cautioned that raising interest rates in response to this supply-side shock could push rates to 'seriously high' and 'recession-inducing' levels, warning that central banks are 'on the verge of policy mistake territory' as expectations for rate hikes grow [1].
The European Central Bank (ECB) and Bank of England (BoE) both held rates steady last week, despite eurozone inflation reaching 3% in April and the U.K. dealing with higher oil prices [1]. However, investors are now pricing in a possible ECB rate hike in June, and BoE governor Andrew Bailey indicated that a prolonged energy price shock could force the bank to raise borrowing costs [1]. In contrast, the Reserve Bank of Australia has already raised rates by 25 basis points to 4.35% after headline inflation in Australia rose to 4.6% in March from 3.7% the previous month, driven by higher fuel prices [1].
Howard argued that the traditional central bank response of raising rates to counter energy-driven inflation is misguided, as such measures would require extremely high rates that could induce a recession [1]. He emphasized that central banks cannot address the supply-side nature of the shock, stating, 'Central banks can't print molecules of oil,' and suggested that while rate hikes may help curb second-round inflation effects like wage demands, targeting energy costs directly with monetary policy is ineffective [1].
Looking at the U.S., Viktor Shvets, head of global desk strategy at Macquarie Capital, noted that 'anything is possible over the next six months,' predicting that U.S. inflation could reach 4% or higher as the country faces a 'mild version' of stagflation [1]. Howard also referenced the aftermath of the Ukraine war, where U.S. services inflation remained relatively muted as consumers reduced spending on non-energy items to accommodate higher energy costs, suggesting that the inflationary impact may not be as severe as anticipated [1].
CONCLUSION
Central banks are under pressure to respond to the Iran oil shock with rate hikes, but strategists warn this could trigger a global recession without effectively addressing the supply-driven inflation. While some central banks have already acted, others remain cautious, and analysts highlight the risk of policy mistakes and the potential for stagflation in major economies.