The Middle East conflict has continued to elevate the importance of energy markets, with clarity remaining low over the duration of the conflict and the ensuing blockade of the Strait of Hormuz. Brent crude closed north of US$100/bbl for the first time since 2022, and now the second-order effects - the impacts on inflation and growth - are being worked through, driving cross-asset volatility. Increased inflation expectations have sent nominal yields higher, while the global rates outlook has been hawkishly repriced. The question ahead of the plethora of central bank meetings next week (Fed, ECB, BoE, SNB, BoJ, BoC and RBA) is what policymakers have to say about the situation: will they view the price shock as temporary and attempt to look through it or - wary of what happened following the Ukraine war - will they show signs of being more proactive.
A 25bps rate hike to 4.10% at next week's RBA meeting has shot into favoritism, after hawkish comments by Deputy Governor Hauser warned of the inflationary risks stemming from the Middle East conflict. The market-implied odds of a 25bps hike - sitting below 20% at the start of the week - surged to around 70% as Hauser speaking on The Conversation podcast said the conflict would see inflation rise above the Bank's February forecasts (which among other variables factored in brent crude oil in the low US$60s), while GDP growth in the December quarter (0.8%q/q, 2.6%Y/Y) and data on the labour market had been stronger than expected.
Hauser, however, also highlighted that there were risks associated with tightening into an outlook made more uncertain by the conflict, while higher oil prices would act as a tax on consumption and output. But markets have run with Hauser's more hawkish remarks. Effectively, the timing of the next rate hike - whether next week or in May (as was previously expected) - won't change the outlook greatly. The more important point in the debate is whether the conflict calls for an additional hike, given it will add to the already high domestic inflation pressures.
A hawkish repricing of the rates outlook has also taken place in Europe, coming ahead of next week's BoE and ECB policy meetings. Neither central bank will change policy (BoE 3.75% and ECB 2%) but the messaging will be key given markets have responded to the conflict by starting to price in rate hikes, with the memory of the inflationary surge following the energy price shock stemming from the Ukraine war still firmly in mind, even if there are differences this time around. That is a significant change given markets were as recently as last month pricing in two rate cuts from the BoE this year, while the ECB was seen remaining on hold.
In the US, the Fed goes into next week's meeting with markets having moved towards pricing out the two rate cuts previously expected for this year. Data this week confirmed inflation was elevated ahead of the crisis. In January, the PCE deflator - the Fed's preferred measure - was well above target at 3.1%yr (the series was delayed by the government shutdown), while in February, headline CPI came in at 2.4%yr and core CPI was at 2.5%yr - both measures unchanged from January's reads. At next week's meeting, the Fed will update its key forecasts and the interest will be around whether the majority of FOMC members still see rates being cut once this year, as was the case in the last set of projections back in December.
