Middle East Conflict Reshapes Expectations, ‘Super Central Bank Week’ Arrives.

TradingKey - This week, global central banks will usher in the most intensive "Super Central Bank Week" of the year. From Washington to London, and Brussels to Tokyo, nearly 20 central banks will convene at the interest rate meeting tables to assess, for the first time, the ripple effects on the global economy more than two weeks after the outbreak of the U.S.-Iran conflict.

As the situation in the Middle East pushes up energy prices, central bank officials are becoming increasingly aware of the risk of an inflation resurgence. This may force many countries to postpone their planned interest rate cuts, and even the resumption of rate hikes cannot be ruled out in extreme cases. However, there is currently no urgency for a policy pivot, as major central banks are still evaluating the specific impact of soaring energy costs on consumer prices and economic growth.

"Central banks can set interest rates, but they cannot reopen the Strait of Hormuz," noted macroeconomist Tom Orlik. "Central bank governors such as Powell, Lagarde, and Bailey are likely to hold steady this week, issuing warning signals and praying that the situation in the Middle East subsides quickly before it evolves into another insoluble inflation crisis."

The transmission mechanism of the energy shock is emerging, pushing up inflation from the supply side in the short term while dampening economic growth from the demand side, creating a classic "stagflation" risk. This has forced central banks to strengthen their "data-dependent" frameworks in policy guidance—if the oil price shock persists, priority will be given to protecting inflation targets over stimulating economic growth.

Industry insiders believe that this "Super Central Bank Week" will mark a key turning point for global monetary policy as it shifts from "easing expectations" to a stance of "cautious wait-and-see."

Fed Policy Trapped in a Dilemma

The Federal Reserve will hold its March monetary policy meeting this week. While the market widely expects the Fed to leave interest rates unchanged, the policy outlook—once certain a few weeks ago—has been completely disrupted by labor market volatility and the surge in oil prices triggered by the Middle East situation.

The contradictory combination of "negative non-farm payroll" data and oil prices exceeding $100 is striking at the Fed's dual mandate of maintaining price stability and full employment, blurring the short-term interest rate outlook.

Previous market expectations for a Fed rate cut in 2026 have largely dissipated, yet there remains a leaning toward accommodative policy. This could make U.S. monetary policy an outlier within the G7, as other major central banks are generally expected to hike rates within the year.

Morgan Stanley economists reiterated that the Fed might cut rates by 25 basis points each in June and September. Although the timing of these cuts could be delayed, it implies that more aggressive policy moves might be necessary in the future.

Commerzbank economist Christoph Balz, however, believes that even if oil prices remain high for an extended period, the likelihood of a Fed rate cut remains higher than a hike, given the political pressure ahead of the November election.

However, as the conflict with Iran pushes up fuel prices, a question unimaginable weeks ago has surfaced: Will the Fed's next move be a rate hike? Derivatives traders currently estimate a roughly 25% probability of a rate hike this year. This shift in expectations underscores the direct impact of geopolitical conflict on energy markets and the inflation outlook, forcing investors to reprice the Fed's policy path. Although most economists still expect a hold at this meeting, the discussion of a rate hike is no longer a taboo subject.

Carl Weinberg, Chief Economist at High Frequency Economics, explicitly called for the Fed to raise rates at this meeting. He predicts that by this summer, oil prices will push the Fed's core inflation gauge, the PCE, to an annualized rate of 3.5%, and the Fed should act preemptively to avoid price runaway. He believes that even if there is no hike at this meeting, officials will certainly discuss the option, and Powell's comments at the press conference will release key signals.

Nevertheless, the prevailing view remains that a short-term rate hike is unlikely.

Former Dallas Fed President Robert Kaplan urged patience, suggesting that the situation could change by the end of March. Former senior Fed official Vincent Reinhart noted that most within the Fed still lean toward easing but will not rush into action; the events in the Middle East simply provide more reason to wait.

Matthew Luzzetti, Chief US Economist at Deutsche Bank, emphasized that a rate hike would require a significant strengthening of the labor market. However, with the U.S. job market averaging only 6,000 new jobs over the past three months, this condition has clearly not been met.

Markets will closely monitor policy signals from this meeting, particularly changes in the Summary of Economic Projections (SEP) and the dot plot—expectations for two previous rate cuts have faded significantly following the surge in oil prices. Gregory Daco, Chief Economist at EY, pointed out that supply shocks are the Fed's most difficult challenge, as they push up inflation while suppressing output, putting policymakers in a dilemma.

While U.S. inflation has retreated from its peak of 9.1%, it remains well above the 2% target. Diane Swonk, Chief Economist at KPMG, warned that if the conflict persists, inflation could surge back above 4%.

The labor market also harbors hidden concerns. Employment unexpectedly fell by 92,000 in February, and the unemployment rate rose to 4.4%. Although a reduction in labor supply due to Trump's immigration policies has masked some unemployment pressure, signs such as the hiring rate hitting a decade low, slowing wage growth, and companies discussing the replacement of labor with AI all indicate that the job market is cooling.

Amid this uncertainty, market expectations for Fed rate cuts have been significantly downgraded, with some even suggesting that the option of a rate hike could return to the agenda.

Gregory Daco believes this chaotic situation means the Fed is more likely to keep interest rates unchanged for a "long period," and Powell's remarks at this meeting will serve as a key clue for the market to judge future policy directions.

Will the Bank of Japan Act This Week?

On Thursday, the Bank of Japan (BOJ) will hold its monetary policy meeting. Markets generally expect the bank to maintain its benchmark interest rate while emphasizing that it remains on track for policy normalization.

Governor Kazuo Ueda is expected to highlight Japan's heavy reliance on Middle Eastern oil and call for close monitoring of geopolitical developments, noting that sustained high crude oil prices could not only drag down Japan's economic recovery but also exacerbate inflationary pressures.

Furthermore, the policy tone must be carefully managed. Dovish signals could further drive down the yen, which hit its lowest level of 2024 last Friday. The risk of currency depreciation must be factored into the assessment.

Traders will scrutinize the meeting statement and Ueda's remarks for clues about policy direction. The market is currently closely watching the possibility of a BOJ rate hike in April. Earlier this month, people familiar with the matter revealed that a rate hike in the spring could not be ruled out.

Despite the uncertainty added by the Middle East situation, expectations for an April rate hike remain stable. Industry analysis suggests that if the upcoming "Shunto" labor negotiations result in a substantial wage increase agreement, and if the Russia-Ukraine and Middle East conflicts do not worsen further, the path for an April hike will be cleared.

On the currency front, hawkish signals from this meeting might temporarily curb the recent upward momentum of the USD/JPY pair. However, markets are also wary that if the USD/JPY exchange rate breaks the 160 level, Japanese authorities could initiate foreign exchange intervention even before the meeting.

ECB, BoE, SNB, and BoC to Hold Policy Meetings

The Swiss National Bank's (SNB) first annual meeting this Thursday comes at a critical juncture. So far this year, the Swiss franc has risen 2.8% against the euro and remains strong against the dollar and pound. Recent geopolitical tensions have further boosted safe-haven demand for the franc. Reports suggest the SNB has intervened in the currency market, but to limited effect. The market expects the bank to maintain rates at zero, with a return to negative rates unlikely; even dovish signals may struggle to reverse the franc's appreciation, making aggressive intervention perhaps the last resort.

The situation in the Middle East has completely altered policy expectations for the Bank of England (BoE). Before the conflict, the market saw an 80% probability of a rate cut in March, but now rate cuts in 2026 have been entirely ruled out. The pound has benefited, significantly outperforming the euro, but given the BoE's dovish tradition, this rally may be overextended. If the meeting lacks hawkish signals, the pound could face a correction.

Despite the UK economy's unexpected stagnation in January and weak growth prospects, surging oil prices have forced officials to refocus on inflation. Economists at ING and RSM UK warned that if high oil and gas costs persist, inflation could rebound to more than double the 2% target. Against this backdrop, the BoE is highly likely to keep interest rates unchanged, and the rate-cut options previously mentioned by Governor Andrew Bailey have been temporarily shelved.

The Bank of Canada (BoC) will announce its interest rate decision this Wednesday, with policymakers facing multiple contradictions. Rising oil prices support energy exports, but a weak Chinese economy and U.S. tariff pressure are weighing on external demand. The market currently expects the bank to maintain its policy rate at 2.25%, but attention is on Monday's February inflation data (reflecting pre-conflict price pressures) and Friday's post-meeting employment data (which may show a sharp drop in February jobs). Governor Macklem's press conference will reveal the impact of the Iran crisis on the policy outlook; a dovish signal could dampen expectations for a rate hike this year, affecting the Canadian dollar.

In stark contrast to the U.S. policy dilemma, the European Central Bank's (ECB) focus remains anchored on inflation. Even as economic growth faces risks, market expectations for further easing by the ECB have completely evaporated. On Thursday, the ECB will hold its monetary policy meeting. The market widely expects the bank to keep the deposit rate unchanged, but the Middle East crisis has shattered the policy "comfort zone" previously claimed by President Lagarde and her colleagues.

Soaring energy prices are driving market bets on an ECB rate hike, forcing the bank to clearly explain the evolution of inflation risks at the meeting and disclose how far the current policy is from the tightening the market expects. Many investors are comparing the current energy shock to the crisis following the Russia-Ukraine conflict in 2022, when the ECB became decoupled from the market due to its stubborn resistance to rate hike pressures. While the ECB will strive to avoid repeating past mistakes, it is unlikely to rush into a rate hike at this time.

RBA Rate Hike Probability Soars

As the first major central bank to start hiking rates this year, the Reserve Bank of Australia (RBA) raised its cash rate to 3.85% last month, citing domestic supply constraints, persistent price pressures, and excess aggregate demand as the core reasons.

On Tuesday, the bank will announce its latest interest rate decision. The market now widely believes that the RBA is likely to hike rates for the second consecutive time.

Since the January rate hike, the RBA has maintained a hawkish policy tone. Deputy Governor Andrew Hauser previously warned that "rising oil prices pose an upside risk to inflation," a statement that has further strengthened market expectations for a hike this month. Recently released economic data has also further confirmed the resilience of the Australian economy.

The surge in oil prices triggered by the escalation of the U.S.-Iran conflict has added new uncertainty to the country's inflation outlook, intensifying market concerns about rising domestic prices.

The decision is a difficult balancing act for RBA officials. Another rate hike would consolidate the central bank's policy credibility in fighting inflation, but it also carries the risk of over-tightening policy amid highly uncertain global geopolitics and economic prospects. Markets will focus on the policy statement and Governor Michele Bullock's post-meeting press conference to judge whether last month's hike marked the start of a new tightening cycle.

How Central Banks Balance Inflation and Growth

Overall, the policy meetings of the seven major central banks serve as both a collective response to current economic challenges and a test of policy confidence.

Against a backdrop of tight energy supplies, resurgent inflationary pressures, and an unclear economic growth outlook, every statement and judgment from central banks will become a key variable affecting global market trends. The subsequent evolution of the energy crisis and the speed of central bank policy responses will jointly determine the trajectory of the global economy in the coming months.

Notably, central bank policy communication often has a more profound impact on markets than the interest rate decisions themselves. Officials' remarks regarding inflation risks, economic growth pressures, and the persistence of energy shocks will directly influence investors' assessments of the future interest rate path.