Inflation and Rate Hike Expectations Amid US-Iran Conflict

- The macro environment today is different from 2022/23, with the chance of central banks restarting a rate hike cycle currently low

- Back then, there was a global halt in production, with no substitutes available; loose monetary policy and economic overheating triggered secondary inflation effects

- Today, only the energy supply in certain regions has been disrupted; despite high energy prices, there has been no second wave of inflation effects.

The ongoing conflict between the US and Iran has driven up inflation expectations, with markets concerned that central banks may trigger another rate hike cycle similar to those in 2022 and 2023. However, the current inflation environment is incomparable to that period, and the likelihood of central banks restarting a rate hike cycle remains low for now.

The previous rate hike cycle was mainly due to global supply chain disruptions and demand shocks caused by the pandemic. At that time, many industrial supply chains worldwide were interrupted, leading to shortages in Country A while other countries also halted production, unable to fill the gaps. Even if goods could be produced, global ports and shipping often faced bottlenecks. Despite being willing to pay high prices, alternatives were not always available, and the impact was not limited to a single region but was global. In contrast, although this Middle East conflict has disrupted the Strait of Hormuz shipping lane, affecting maritime energy transportation, it has not caused a halt in global production capacity. Buyers can still import energy from other markets at higher prices.

In the later stages of the pandemic, as cities gradually returned to normal, a large amount of pent-up demand was released. Governments around the world implemented monetary easing policies, stimulating the economy through ultra-low interest rates, which led to economic overheating and triggered secondary inflation effects. The outbreak of the Russia-Ukraine war in 2022 further exacerbated inflationary pressures by affecting supplies such as natural gas. The US Consumer Price Index (CPI) once surged to 9.1% in June 2022. To curb inflation, the Federal Reserve raised interest rates 11 times, lifting the federal funds rate to a 22-year high of 5.25-5.5%, while the European Central Bank also raised rates from -0.5% to 4%.

This time, the Middle East crisis has not pushed up consumer demand, and there is no risk of economic overheating. Before the conflict, inflation in Europe and the US had steadily declined. After the conflict, US inflation rebounded in March, but the rise is expected to be temporary. Although the situation remains fragile, both the US and Iran are unlikely to escalate military actions again. Given that the US midterm elections are only six months away, high gasoline prices and inflation rebounds would harm the Republican Party’s election prospects; on the other hand, Iran cannot afford to lose oil revenue for an extended period. Therefore, the situation is expected to ease gradually, bringing down energy prices.

The previous rate hike cycle aimed to reverse the then-loose monetary policy and suppress overheated demand. Currently, interest rates in Europe and the US are generally at neutral levels, neither expansionary nor supportive of growth. Monetary policy cannot directly address supply shocks, and raising rates at this stage might instead suppress economic growth and employment. Central banks’ focus now is on balancing inflationary pressures with risks of a slowing labor market. With inflation trends still unclear, the central banks of the US, Japan, Canada, and the UK maintained interest rates after their April meetings. Significant rate hikes are likely only if long-term inflation expectations continue to rise strongly alongside robust wage growth.

Although the Middle East conflict has increased inflation, the overall environment differs from the pandemic period. Adjusting interest rates prematurely at this stage could lead to undesirable economic fluctuations. Given the absence of second-round inflation effects triggered by rising energy prices, central banks currently do not have plans to start a new round of rate hikes. Under current market conditions, diversifying investments through a balanced stock-bond portfolio can help investors mitigate risks and cushion against market volatility.

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