Global interest rate markets are optimistically betting that the Middle East conflict will end within weeks; however, the surge in energy prices has already reshaped expectations for monetary policies across countries: the likelihood of a Bank of England rate cut in March has dropped sharply, the probability of a European Central Bank rate hike within the year has risen to 20%, and the Federal Reserve’s rate-cutting path remains largely unchanged. Experts warn that if the conflict persists for several months, inflationary pressures could substantially bring the current easing cycle to an end.
Following the strikes by the United States and Israel on Iran, global interest rate markets are making a critical assessment: this conflict will conclude within weeks rather than escalating into a protracted war. While this optimistic outlook is preventing the market from heading toward the worst-case scenario, the sharp rise in energy prices has begun reshaping monetary policy expectations in the UK, the Eurozone, and the United States.
According to reports from CCTV News and Xinhua News Agency, the United States and Israel launched a large-scale joint military strike against Iran on February 28. On March 5, media reports indicated that after the military action over the previous weekend, oil transit through the Strait of Hormuz plummeted to a trickle, with threats of retaliation from Iran bringing shipping to a standstill. Prices for energy commodities such as oil and natural gas surged significantly, with natural gas prices doubling since the previous weekend.
Neil Crosby from Sparta, a commodities research firm, warned: "Forget about the issue of oil surplus; the market is now staring at a massive gap in the global oil supply."
Nevertheless, markets currently continue to assume that the duration of the conflict will be limited. The probability of a Bank of England interest rate cut in March dropped sharply from 75% to 25%, while the likelihood of a European Central Bank rate hike within the year rose to 20%. Meanwhile, the Federal Reserve’s easing trajectory remains largely unchanged — markets are betting that Trump has sufficient political motivation to keep the conflict short-term.
However, several economists have explicitly stated that if the situation persists for months, inflationary pressures will materially alter the pace of rate cuts and may even bring an end to the current easing cycle.
Bank of England: A March Rate Cut Nearly Off the Table
The impact of this conflict on expectations for UK monetary policy has been the most direct. Just a week ago, markets were pricing in a 75% chance that the Bank of England would lead with a rate cut at its March meeting; now, that probability has fallen to 25%.
Paul Dales of Capital Economics stated that the surge in natural gas prices is the key variable. "Natural gas prices have doubled since the previous weekend, but the crucial question is how long elevated prices will persist and when they will begin affecting inflation."
He is maintaining his forecast of three rate cuts within the year but added, "If the situation continues, revising the forecast is only a matter of time." He also noted that the March meeting is just weeks away, "and without clear signs of de-escalation, I believe the central bank will skip the anticipated rate cut this time."
Sanjay Raja of Deutsche Bank provided a more specific quantitative estimate: the direct impact of current oil prices on CPI is approximately 10 to 15 basis points. If natural gas prices remain elevated in the coming months, the average dual-fuel household energy bill could increase by about 18%, reaching an annual cost of 1,900 pounds.
He also pointed out that the price cap window has just opened, and if the situation in the Middle East eases in the coming weeks, there is still room for adjustment.
Raja also raised the possibility of a 'hawkish rate cut': If the market-priced probability of a March rate cut rises above 40%, the Monetary Policy Committee might opt to implement a precautionary rate cut, but at the same time issue more cautious forward guidance. This could imply an early end to this easing cycle and push up terminal rate expectations.
European Central Bank: Calm Broken, Rate Hike Probabilities Emerge
The outbreak of the Iran war has shattered the calm maintained by the European Central Bank since last summer. Previously, analysts almost unanimously expected eurozone interest rates to remain within a 'comfortable range' of 2% for this year and next; now, the forward-rate market has priced in a 20% probability of a European Central Bank rate hike within the year.
Eurozone inflation data shows that the overall inflation rate in February was 1.9%, slightly below target. However, analysts noted that the previously existing possibility of inflation being below target within the year has now shifted to a risk of exceeding the target due to the situation in the Middle East.
Nevertheless, several analysts believe that the Eurozone's resilience to shocks this time is stronger than during the Russia-Ukraine war in 2022. Marco Valli of UniCredit stated:
"The resilience of the Eurozone economy over the past year has exceeded expectations. Compared with 2022, energy supplies are more diversified, and resistance to shocks is stronger. The fact that global energy markets were in a state of oversupply prior to this crisis also helped. With inflation slightly below target, the European Central Bank has room to breathe and can afford to wait and see."
Analysts at Pantheon warned that the jump in energy prices will weigh on both consumer and business confidence, threatening an already uncertain growth outlook, and they expect the European Central Bank to refrain from raising interest rates in the short term.
Federal Reserve: Political Logic Supports Market Optimism
Compared with the UK and the Eurozone, the policy expectations for the Federal Reserve have been the least impacted. The forward-rate market still fully prices in two rate cuts in 2026, with only a small amount of hawkish sentiment seeping in—last week, the market was pricing in a low probability of a third rate cut, which has now dissipated, but the market has not significantly shifted toward a 'no rate cut' scenario.
Analysts believe that Trump's political interests are the key logic supporting this optimistic expectation. Bernard Yaros of Oxford Economics pointed out:
"The Federal Reserve will choose to ignore the price increases brought about by the Iran conflict, while remaining vigilant about its impact on the growth side — consumers are already under pressure, real income growth is trending toward stagnation, and higher energy prices will only exacerbate the situation."
Analysts generally believe that as the midterm elections approach, any rebound in inflation or damage to consumer purchasing power will put political pressure on Trump, providing him with a strong incentive to end the conflict quickly.
Goldman Sachs' analysts quantified the situation from the perspective of economic modeling: their oil consumption model shows that rising oil prices will drag down GDP year-on-year growth by approximately 0.13 percentage points in the fourth quarter of 2026, mainly through the channel of compressing household real disposable income; however, the increase in energy capital expenditure will partially offset the drag on consumption, resulting in a net drag of about 0.1 percentage points overall.
Core Variable: Duration of the Conflict
The divergence in all current monetary policy expectations ultimately boils down to the same question: How long will this war last?
The market's baseline scenario at present is that the conflict will end within weeks. If this expectation is not met, the policy dilemmas faced by central banks will intensify sharply — the Bank of England may be forced to pause the entire rate-cutting cycle, the probability of the European Central Bank raising rates will further increase, and the Federal Reserve will also have to seek a new balance between inflationary pressures and slowing growth.
As Capital Economics’ Dales noted, the key difference this time compared to 2022 is: back then, central banks chose to raise interest rates to respond to the energy shock, whereas the current slack in the labor market means that interest rates are more likely to "remain on hold" rather than "rise again." However, in any case, whether the market’s optimistic bets will materialize depends on geopolitical developments rather than economic data itself.
Editor/Lambor
