As summer draws to a close, two interconnected economic pressures – soaring energy costs and the looming prospect of tighter borrowing conditions – have moved to the top of the global policy agenda, bringing central banks across major Western economies into a high-stakes balancing act. For months, skyrocketing crude oil prices have already inflated fuel costs for motorists and eroded disposable household income, and growing uncertainty over the economic fallout of the ongoing US-Iran conflict has fanned fresh fears that cost-of-living pressures will climb even higher in the coming months.
The first major policy move came from the European Central Bank, which recently lifted its benchmark interest rate to 2.5%, justifying the hike by pointing to persistent inflation spurred by Middle East tensions, with officials warning price growth will remain well above the ECB’s 2% target for an extended period. Now, all eyes are turning to the United States and the United Kingdom, where the Federal Reserve and Bank of England are set to announce their latest interest rate decisions next week, starting with the Fed’s announcement on Wednesday.
The Fed has held interest rates steady at between 3.5% and 3.75% for five consecutive policy meetings, with its last adjustment being a rate cut back in December. But shifting economic and political conditions have reshaped market expectations: a persistently robust US job market, paired with comments from former President Donald Trump suggesting oil prices will not fall until the US-Iran conflict concludes – a outcome he predicts will not come until after November’s general election – has led most Wall Street analysts to price in a rate increase at this month’s meeting.
Newly appointed Fed Chair Kevin Warsh has declined to publicly signal his policy preference, but his repeated public remarks emphasizing that the central bank’s top priority is taming stubborn inflation have only reinforced expectations of a hike. Economists at Deutsche Bank recently concluded that a rate increase is “the most likely policy outcome” based on comments from Warsh and other Fed voting members. While there is some dissent – Grace Zwemmer, a US economist at Oxford Economics, still forecasts rates will hold steady – nearly all analysts agree that a rate cut is off the table for the foreseeable future. That puts the Fed on a collision course with Trump, who has publicly pushed for lower borrowing costs and took to social media last week to pressure the central bank, writing: “The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change.”
The root of the current inflation anxiety is the disruption to global energy markets caused by the US-Iran conflict. The Strait of Hormuz, one of the world’s most critical chokepoints for oil and natural gas shipments, has seen restricted traffic amid the fighting, pushing Brent crude prices to around $105 per barrel, nearing the multi-year highs hit when the conflict first broke out. Higher energy costs do not just increase direct utility and fuel bills for households and businesses: they also raise transportation costs for all goods, a burden that is ultimately passed to consumers in the form of higher prices for food and other essential consumer staples.
Central banks traditionally rely on higher interest rates to cool inflation: by raising the cost of borrowing for mortgages, loans and credit cards, policymakers aim to slow overall consumer spending, which in turn eases upward pressure on prices. Higher rates also create an incentive for households to save rather than spend, further cooling demand. But the policy carries major risks: tighter monetary policy can also discourage businesses from investing in expansion and new hiring, potentially dragging overall economic growth lower and raising recession risks. That makes the current decision a delicate balancing act for policymakers.
When the Bank of England announces its policy decision later next week, analysts broadly expect it to leave rates unchanged at 3.75%, even as it faces its own set of inflation pressures driven by higher energy costs. Heading into the winter heating season, millions of UK households are set to see their energy bills jump to the highest level in three years, and UK natural gas prices have already climbed above 200p per therm for the first time since the end of 2022. UK inflation currently stands at 2.9%, and most economists predict it will tick up sharply in the coming months due to higher energy costs.
Despite these inflation headwinds, analysts say there is little pressure on the Bank of England to hike immediately, thanks to key differences between current conditions and the 2022 global inflation shock. Unlike 2022, when the UK economy was rebounding from Covid-19 lockdowns and hiring was booming, the current labour market is far cooler: hiring activity is well below average, and employers face far less pressure to fill vacant roles, which means workers have far less leverage to demand large pay increases. Oxford Economics economist Alexander Harvey notes there is “no sign” of the so-called second-round inflation effects that worried policymakers in 2022 – where price shocks lead to wage-price spirals as workers demand higher pay and businesses pass those costs on to consumers. That gives the Bank of England “some breathing space,” Harvey said.
Yael Selfin, chief economist at KPMG, added that outside the United States, economies like the UK are already far weaker than they were in 2022, when the last major energy-driven inflation shock hit. Consumers, still reeling from previous rounds of price hikes, have already adjusted their spending habits, and interest rates are already much higher than they were four years ago. “That’s in stark contrast to the current labour market,” Harvey said of the 2022 conditions, when post-Covid reopening left businesses scrambling to hire and gave workers unprecedented bargaining power to push for big pay gains. Today, those conditions no longer exist, giving UK policymakers room to hold off on further tightening for now.