Middle East conflict puts central banks in crisis as oil shock fears grow

The escalating conflict in the Middle East is posing a new challenge for the world’s central banks, as concerns about oil shocks and new inflation risks complicate policymakers’ calculations to boost growth.

Oil prices soared on Monday after the United States and Israel launched attacks on Iran over the weekend that killed Iranian Supreme Leader Ali Hosseini Khamenei. The Iranian government responded with missile attacks targeting several Gulf states.

Tanker traffic through the Strait of Hormuz, the world’s most important chokepoint for oil shipments, has come to a virtual standstill as threats of attack from Iran have blocked ships from passing through the waterway.

Brent crude oil prices rose for a fourth day, rising 1.6% to $82.76 per barrel on Wednesday, hovering near their highest since January 2025. West Texas Intermediate Crude oil prices also rose for the third day in a row to $75.48.

Especially in economies that rely heavily on oil imports from the Middle East, rising energy prices will eventually spill over into consumer and producer prices, forcing central banks to reassess the trajectory of interest rates.

“The ongoing conflict in Iran solidifies the rationale for many central banks to keep interest rates on hold for the time being,” Nomura’s economist team said in a note on Sunday.

As rising tensions weigh on economic activity, policymakers are grappling with the delicate task of balancing inflation risks and slowing growth.

The European Central Bank is in what ING economists call a “real dilemma” as the pressure of higher U.S. tariffs weakens growth prospects, while the oil shock could further push up already sticky inflation. “For rate hikes to be possible, the euro area economy needs to show clear resilience,” he added.

Europe imports nearly all of its oil and a significant portion of its liquefied natural gas, raising the risk of a double energy and trade shock, the central bank said.

ECB Governing Council member Pierre Hounche said this week that officials would avoid reacting hastily to changes in energy prices. “If it continues for a long time and the energy price increases get even bigger, we’ll have to run the model and see what happens,” Wansch said.

Former Treasury Secretary Janet Yellen said the conflict could hurt U.S. economic growth, fuel inflationary pressures and deter the Federal Reserve from cutting interest rates.

“Due to the recent developments in Iran, the Fed has held off on further rate cuts and is now more reluctant to do so than it was before the incident,” Yellen said on Monday.

U.S. inflation was 2.4% in January, above the Fed’s 2% target. Yellen warned that President Donald Trump’s tariffs could push annual inflation to at least 3%.

The latest deterioration comes after President Trump threatened earlier this year to seize oil-rich Venezuela and take control of Greenland, another strategically important energy deposit.

Brent crude oil is up 36% so far this year, and WTI futures are up 32% as of Wednesday, according to LSEG data.

Global energy markets are facing a worst-case scenario, with prolonged disruption in the Strait potentially pushing Brent crude oil prices above $100 per barrel and European natural gas prices topping 60 euros ($70.17) per megawatt hour, according to Bank of America.

Asian economies will be particularly at risk. Most of the crude oil shipped through the Strait of Hormuz goes to China, India, Japan and South Korea, according to the U.S. Energy Information Administration.

According to Goldman Sachs, inflation in Asia could rise by about 0.7 percentage points under the assumption that the Strait of Hormuz is closed for six weeks and oil prices rise from $70 to $85 a barrel. The Philippines and Thailand are expected to be the most vulnerable, while China could see a “more moderate increase.”

Michael Wang, senior currency analyst at Bank of Mitsubishi UFJ, said central banks in Asia such as the Philippines and Indonesia may pause interest rate cuts as oil prices continue to rise, while policymakers in India and South Korea are likely to keep rates unchanged for an extended period of time.

BMI, a unit of Fitch Solutions, estimates that the dispute could increase consumer inflation across Asia by 7 to 27 basis points, with Thailand, South Korea and Singapore particularly affected by the largest impact due to their high weight in energy in inflation calculations.

“In the case of a 10% oil shock, the increase in inflation is small enough that most people are likely to pass by. (But) a $20-30 per barrel increase would change the calculations significantly, doubling or tripling headline CPI, making the second-round impact difficult to ignore,” the research firm said.

The report said interest rate hikes are largely off the table at this point unless higher oil prices keep transport and freight costs rising, which spills over into food and other goods and feeds into higher core inflation.

Nomura expects “relative beneficiaries” Malaysia, Australia and Singapore, which are net energy exporters, to also raise interest rates. The bank also lowered its expectations for an interest rate hike by the Philippine central bank.

“The rise in oil prices has increased confidence that Bank Negara Malaysia will raise interest rates and that Bank Pilipinas may keep rates unchanged compared to the previous benchmark of another 25 basis points cut in April,” Nomura said.

The bank estimates that the impact of rising oil prices on Singapore’s GDP growth rate will be around 0.01 percentage point.

Indonesia and Singapore said on Monday they were closely monitoring financial markets. Bank Indonesia said it would act to keep the rupiah in line with economic fundamentals, while the Monetary Authority of Singapore said it was assessing the impact of the dispute on the domestic economy and financial system.

Fiscal stimulus and subsidies could cushion some of the impact of inflation and relatively benign price pressures into 2026, providing a relatively comfortable starting point.

“We expect Asia to use fiscal policy as a first line of protection for consumers,” Nomura economists said. Possible measures include price controls, increased subsidies, reduced fuel consumption taxes, and lower import duties on crude oil and refined products.

But Rob Subbaraman, head of global macro research at Nomura, said on CNBC’s “Squawk Box Asia” on Tuesday that the subsidies could put a new burden on governments’ already strained budget deficits.

“So which ‘negative’ do you want, higher inflation or worsening public finances? These are policy choices that the government must make.”