Central banks stand ready to tackle war-led inflation

By William Schomberg and Balazs Koranyi

LONDON/FRANKFURT, March 19 (Reuters) – Top central banks on Thursday said they stood ready to tackle any surge in inflation with tighter policy as the latest escalation in the Iran war put the Middle East’s vital energy infrastructure in the line of fire, pushing fuel prices higher.

In a rare coincidence of the monetary policy diary, central banks of the United States, Japan, Britain, Canada and the euro zone – effectively the Group of Seven (G7) nations – convened this week, as have counterparts from several emerging economies.

After facing criticism they acted too late to tame a post-COVID jump in inflation exacerbated by the Russian invasion of Ukraine in 2022, policymakers are determined to rein in prices without derailing still-patchy economic growth – and above all to avoid a “stagflation” mix of recession and price surges.

The U.S. Federal Reserve and the Bank of Canada on Wednesday both opted to hold interest rates steady, as did the Bank ofJapan, the Bank of England, the European Central Bank and the central banks of Switzerland and Sweden on Thursday.

Yet they made clear they are on alert, wary that rising energy prices could spark a wave of inflation across the wider economy if, for example, it starts to prompt higher wage demands by households fearful of losing purchasing power.

“Monetary policy cannot reverse the shock to (energy) supply,” Bank of England Governor Andrew Bailey said in his commentary of the unanimous decision by the bank’s policy-making committee to keep rates on hold.

“Monetary policy must, however, respond to the risk of a more persistent effect on UK CPI inflation,” he added. After the move, traders priced in two 25-basis-point rate hikes by year-end, up from just one prior to the meeting.

In its statement, the ECB said the leap in energy prices prompted it to revise upwards its 2026 inflation forecast for the euro area to 2.6% – above its 2% target – but said the long-term impact was still unclear.

“The war in the Middle East has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth,” it said.

US RATE HIKE STARTS TO GET PRICED IN

Marking an escalation in the three-week war, Iranian strikes since Wednesday have caused extensive damage to the world’s largest gas plant in Qatar and hit other Gulf infrastructure in retaliation for Israeli attacks on its own gas facilities.

Such strikes already start to make it more likely that the global economy will have to grapple with longer-term damage to energy supplies. But Federal Reserve Chairman Jerome Powell noted that quantifying that hit was still impossible.

“In the near term, higher energy prices will push up overall inflation, but it is too soon to know the scope and duration of the potential effects on the economy,” Powell said after the Fed’s 11-1 decision to hold rates in the 3.50%-3.75% range.

His reluctance to say that risks of a weakeningjob market posed a greater risk to the Fed’s objectives thaninflation helped push market rate-cut expectations into 2027 and even raised odds of a hike at the next meeting to 12%.

In Tokyo, Bank of Japan Governor Kazuo Ueda said the BOJ would not rule out a near-term rate hike if the expected hit to growth from surging oil costs proves temporary, and does not derail progress in durably hitting the bank’s price target.

“We need to be mindful that recent developments come at atime when companies are already actively pushing up prices andwages, which suggests they could pass on costs more aggressivelythan after the war in Ukraine,” Ueda told a news conference.

Bank of Canada Governor Tiff Macklem struck a similar note: “If energy prices stay high, we will not let their effects broaden and become persistent inflation,” he said.

GROWING ‘STAGFLATION’ RISK?

Earlier this week the Reserve Bank of Australia hiked rates to a 10-month high and warned of a “material” risk to inflation from the oil price spike.

Even Brazil’s central bank, with one of the highest rates of all major economies, opted for a cautious 25-basis-point cut to a benchmark 14.75% rate – a smaller cut than initially expected.

On Thursday both the Swiss National Bank and Sweden’s Riksbank kept policy rates on hold, flagging the uncertainty of how the war will end up impacting the economy.

European markets fell sharply on Thursday and U.S. stock futures dipped as the attacks targeting energy infrastructure pushed benchmark Brent oil prices above $119 a barrel.

“This latest escalation feels like a turning point formarkets because the conflict is no longer just about militaryheadlines or Strait of Hormuz closure,” Charu Chanana,chief investment strategist at Saxo in Singapore, said.

“It is now hitting the plumbing of the global energy system.What is unsettling markets now is the growing stagflation risk.”

(Reporting by Promit Mukherjee in Ottawa, Howard Schneider in Washington and Leika Kihara in Tokyo; Writing by Dan Burns and Mark John; Editing by Lincoln Feast, Shri Navaratnam, Alexandra Hudson and Andrew Heavens)