The Iran war has put central bankers in a bind. Nobody knows how long shipping in the Strait of Hormuz will remain disrupted for, and in turn how high global energy prices could ultimately rise. Households and businesses are, however, already feeling the pinch from dearer domestic fuels. Data released on Tuesday showed that annual growth in the US consumer price index jumped to 3.8 per cent in April, its highest in three years, and up from 2.4 per cent in February.
If rate setters act too soon to contain inflationary pressures by raising the cost of credit, they risk adding insult to economic injury. If they hold steady to see how the conflict develops, there is a risk of waiting too long. Then they could be blamed for a surge in prices, similar to what happened in the aftermath of the pandemic and the Russian invasion of Ukraine in 2022. That said, central bankers are also aware that monetary policy is a rather blunt instrument for guiding prices through a volatile shock to energy supplies.
The strategy, so far, among major central banks has been to bide time. But the longer the conflict goes on, the more patience will thin, and the more hawkish policymakers will become. Last week, the Reserve Bank of Australia and Norges Bank bucked the trend by raising rates. And at their meetings last month the US Federal Reserve, European Central Bank and Bank of England conveyed growing concern about the pass-through of higher energy costs into the economy. Kevin Warsh, who is set to replace outgoing Fed chair Jay Powell this week, will face stiff resistance from a Federal Open Market Committee that is anxious about inflation if he pushes for a rate cut to appease US President Donald Trump.