Central banks warn inflation fight not over as Middle East tensions linger

FRANKFURT/TOKYO, June 18 (Reuters) — The Iran war-induced inflation surge is becoming too much for central banks around the world to simply look past, and a string of them, led by the US Federal Reserve, have either raised borrowing costs or signalled likely moves to tame price growth. 

Conflict in the Middle East has pushed up energy costs and even if an interim peace deal holds, so much infrastructure has been damaged and so much oil is missing from stockpiles that energy market normalisation could last well into next year.

This is especially troubling as some big economies, notably the United States and Britain, failed to get inflation back to target after the 2021–22 price shock. Five years of above-target price growth puts their central banks' credibility on the line. 

The Fed signalled possible moves on Wednesday and Bank of England policymakers debated a hike, setting aside conventional economic theory that they should look past a temporary shock. 

The European Central Bank and Bank of Japan have already raised interest rates. The tone shift at the Fed, which was announcing its first monetary policy decision under new Chair Kevin Warsh, is especially notable.

At the start of this year, investors were anticipating two or three US rate cuts in 2026. Now, they are pricing in two increases in borrowing costs, meaning that financing conditions have tightened even before any central bank action.

Because financial markets take their cue from the world's largest central bank, that can create a domino effect for peers. 

“With the Strait (of Hormuz) set to reopen – apparently – it is tempting to think that the global rate-hiking cycle is already over,” TS Lombard's Dario Perkins said.

“That assessment looks wrong,” Perkins said. “Underlying inflation remains too high and growth is set to re-accelerate.”

Trump rate cut not coming

The Fed reinforced that message on Wednesday, with projections that put a rate hike squarely on the table.

“The big picture is that the Fed seems open to raising interest rates,” said Stephen Brown at Capital Economics, adding that its inflation projection alone would suggest it should already be hiking.

The rate cuts once demanded by US President Donald Trump certainly don't seem likely to come any time soon, especially since Warsh plans to set up several committees to review the central bank's operations.

“Warsh's inflation rhetoric was more hawkish than we had expected,” UniCredit said in a note. 

“The FOMC will have little incentive to move while it waits for the committees to deliver their inputs.”

The oil market is also working against inflation, with prices dropping sharply in recent days.

But the price curve is now flat, with Brent crude trading at US$77 (RM324.61) per barrel now and December futures at US$76 (RM320.40), suggesting that markets either do not believe the peace deal will hold or think normalisation will be drawn out as stocks need replenishing.

Effects felt around the world

The “Fed effect” will then reach around the globe.

A sharp slide on Thursday in the Japanese yen prompted fresh talk about intervention and will put pressure on the BOJ to hike borrowing costs further.

“The yen's declines caused by a hawkish-leaning Fed could prod the BOJ to speed up the pace of interest rate hikes,” Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust Asset Management in Tokyo, said.

“We've already seen the weak yen push up long-term inflation expectations, a trend that may continue and keep pressure on the BOJ to hike rates,” Katsutoshi said.

The Bank of England held rates on Thursday but discussed the merits of a hike, while Norway's central bank warned inflation is too high and that borrowing costs are likely to be raised later this year. 

While the BoE was less explicit than most others in signalling higher rates, financial markets have fully priced in a move by the end of the year, especially as the bank's own chief economist continues to advocate a hike. 

The ECB, which last week became the first big central bank to hike rates, has firmly kept more policy action on the table this week, with policymakers cautioning against any expectation of radical improvement on the peace deal. — Reuters