With energy flows in the Middle East still largely blocked and oil prices rising, policymakers in Europe are grappling with the immediate impact of higher costs and trying to determine the potential economic damage of a protracted conflict.
On Thursday, officials from the European Central Bank and the Bank of England are expected to keep interest rates unchanged, but investors are betting that each bank will raise rates at least twice later this year. Economists and lawmakers will be watching closely for signs of how central banks will react to inflation.
The successful closure of the Strait of Hormuz, an important waterway for oil and other goods along Iran’s southern coast, has significantly increased energy prices. Brent crude, the international benchmark, has soared above $100 a barrel, while European natural gas prices are up nearly 40 percent since the United States and Israel attacked Iran at the end of February.
The war had an almost immediate effect on inflation in Europe, raising the prices of fuel at the pump, for airplanes and other operations that require fuel. In Britain, annual inflation rose to 3.3 percent in March and is expected to remain around 3 percent in the second quarter, a point above the bank’s target. In the 21 countries that use the euro, inflation was 2.6 percent in March, up from 1.9 percent the previous month.
But for the central banks, the question is whether higher rates will ripple through the economy and ultimately boost wages, potentially halting the rate hikes that would warrant sharp rate hikes like those in 2022. At the moment, analysts say there is not enough information on how the war, which appears to be on hold, will affect the economy. While President Trump has extended the ceasefire in the region, the population of the crisis remains low.
At the same time, concerns about inflation are being weighed against the fact that the war is harming economic growth. In that case, policy makers will not want to tighten monetary conditions. Consumer sentiment in Germany, the eurozone’s biggest economy, fell to its lowest level in three years, data showed this week. This month, the International Monetary Fund said the bloc’s economy would grow by 1.1 percent this year, but that took a quick decision on the war and the revival of global energy markets.
“The ECB will remain in ‘wait and see’ mode, at least for now,” HSBC analysts wrote in a note. But “the risk of long-term disruptions to energy supply, coupled with the risks of second-round effects on inflation,” increases the likelihood that the central bank will raise interest rates later.
It’s a problem facing big banks far away. This week, the Bank of Japan voted to keep interest rates unchanged, but it was a split decision with several officials favoring a rate hike. The central bank raised its inflation forecast while warning that economic growth is likely to slow this year.
On Wednesday, the Federal Reserve also held interest rates steady. It acknowledged the effect of the war on the economy, saying that inflation had moderated due to “recent increases in global energy prices.”
