The US-Israeli war on Iran has reshaped monetary policies in major economies, with its effects transitioning from geopolitical concerns to the core of economic policies. Central banks are now confronted with a complex equation regarding how to contain inflation arising from supply shocks without triggering a deeper recession or financial disruptions.
Energy prices have surged, leading to a repricing of economic risks and prompting policymakers to adopt a more cautious approach. In this context, European Central Bank Vice President Luis de Guindos warned that the direct exposure of European banks to the war remains limited, but the real danger lies in the potential for systemic pressures arising from the interconnectedness of energy, credit, and financial markets.
Details of the Event
In the United States, Federal Reserve Chairman Jerome Powell indicated that the current interest rate level, which ranges between 3.50% and 3.75%, remains appropriate given the uncertainty. He explained that the central bank prefers to wait and assess the impact of the war and rising energy prices before taking any new steps. These conditions reflect a shift in the nature of inflationary pressures, as inflation is no longer solely driven by increased demand but is now associated with what Lebanese University economics professor Jassem Ajaka describes as a "supply shock."
The rise in oil prices has directly contributed to fueling inflation, theoretically necessitating a tightening of monetary policy through interest rate hikes. However, this response presents a dilemma, as raising rates under current conditions could pressure economic growth and lead to liquidity withdrawal from markets. While increasing interest rates helps contain inflation, it simultaneously exerts pressure on investment, credit, and economic activity.
Context and Background
The equation appears more sensitive in Europe, where rising energy prices have exerted pressure on government bond yields. On March 20, German ten-year bond yields reached their highest levels since the Eurozone crisis in 2011, indicating that the war's effects are spilling over into debt markets, liquidity, and financing costs, particularly in economies more reliant on imported energy.
The current reality places central banks in a double bind: either curb inflation at the expense of growth or maintain economic activity with the risk of entrenched inflation. The Federal Reserve may lean towards patience, especially since the impact of interest rates is delayed, while the oil shock could be temporary. Conversely, Europe faces a more fragile situation due to its greater reliance on imported energy, making it closer to a "stagflation" scenario.
Implications and Effects
The Federal Reserve's caution does not indicate a reduction in pressures but rather reflects a shift in monetary policy from an anticipated easing path to a more defensive stance. The International Monetary Fund has warned that the war has produced an uneven global shock combining rising prices, slowing growth, and tightening financial conditions, with energy-importing economies in Europe and Asia bearing the brunt of the burden.
The Organisation for Economic Co-operation and Development (OECD) forecasts a slowdown in global economic growth to 2.9% in 2026, alongside rising inflation in G20 countries to around 4%. It is also expected that inflation in the United States will reach 4.2% under the pressure of the energy shock and ongoing uncertainty.
Impact on the Arab Region
Economist Firas Shabou believes that the war has shifted the global economy into a phase of "imported inflation" driven by rising energy, transportation, and insurance costs, rather than internal monetary imbalances. He points out that raising interest rates in this case does not address the root of the problem but rather pressures growth. Central banks are now in a position where they "cannot easily lower interest rates, nor can they raise them without cost."
Monetary policies range between three scenarios: tightening through interest rate hikes to curb inflation, selective easing by injecting liquidity without significant rate cuts, or accepting temporarily higher inflation to maintain growth. Concurrently, some central banks have begun using their gold reserves to provide liquidity or support local currencies.
Ultimately, experts indicate that the next phase will be characterized by a cautious stabilization of interest rates, expanding liquidity tools as needed, with the possibility of accepting temporarily higher inflation levels to avoid a deeper recession in an environment marked by high uncertainty.