It’s a packed week full of major central bank meetings – bang on time it would seem – as markets continue to grapple with the Middle East conflict and its impact on the global economy. Understanding how long the conflict and supply shocks will last remains the priority for traders and investors. Mixed messages from the White House and the unknown leadership situation in Iran mean policymakers will likely play for time, with forward guidance that says the next steps will depend on the evolution of energy prices and the impact on inflation expectations.
If crude oil prices retrace quickly, then there’s a chance rate setters continue where they left off pre-war. That means rates cuts for the Fed and BoE have been paused in the near term but not written off completely, while a current ECB hike is priced out. Such a scenario would point to headline inflation staying below 3% in most regions, with officials minded to “look through” these energy price spikes. If the disruption lasts longer, risking more prolonged higher inflation, then officials will be more cautious. That probably means central bankers that are patient with policy action possibly in early summer.
At present, bond markets have shifted sharply in recent days and now lean towards hikes. The Fed is in a relatively good position to wait and see how the war in the Middle East plays out and is not in a hurry to provide strong forward guidance about its next policy changes. The ECB may signal readiness to act to upward price pressures but at the same time acknowledge heightened uncertainty that is too early to draw firm conclusions. The Bank of England is set to pause its cutting cycle as the energy shock blurs the UK’s disinflationary path. Japan is the outlier being on a hiking cycle. Real wage growth turning positive for the first time in over a year in January supports tightening further, though surging energy prices is threatening to undermine the recent purchasing power recovery.
Again, we highlight President Trump’s off-ramp, with a China summit still set for the end of this month, and the midterm elections towards the end of the year. Senior US and Chinese officials will meet in Paris on Sunday, to lay the groundwork for the summit. Our broad playbook remain that China is key in this conflict with gulf oil supplies hugely important for Beijing. More broadly, higher energy costs are inflationary, but they can ultimately be demand destructive, which will push core inflation pressures lower over the medium to longer term.