19 March 2026: Trump’s war on Iran confounds the world’s Central Bankers

The Bank of England’s Monetary Policy Committee will meet today to decide the path of monetary policy as the first quarter of 2026 draws to a close. A lot has changed since the last meeting; economists were confident that inflation would be well on its way to the Bank’s 2% target, which would allow it to provide at least two interest rate cuts this year.

Now, with the oil price expected to remain close to $100 per barrel and further shocks feared, if not expected, the entire outlook has changed.

Several members of the MPC fear the “secondary” effects of rising inflation, with wage demands likely to increase again in a doom loop that will hit growth again.

The Chancellor may be forced to postpone, if not cancel entirely, her self-imposed spending limits, while trying to future-proof the economy. Attempting to run a country’s finances in the hope that there will be no unexpected shocks is the very definition of naivety.

The Prime Minister may be backed into a corner again by backbench MPs from his own Party as the economy reacts to a now likely bout of stagflation, although it should be relabelled “Trumpflation.

When he returned for his second term, Donald Trump vowed to “make America great again”, but no one expected him to try to achieve this with his own economy stagnating and the rest of the world facing major American-driven issues.

Sir Keir Starmer has tried to defy Trump’s expectations of support, but according to this morning’s newspapers, he now stands on the brink of tasking the British military to help reopen the Straits of Hormuz.

The escalation of the conflict following yesterday’s attack on Iran’s part of the world’s largest gas field, which it shares with Qatar, saw the oil price rise again, reaching a high of $108.

All G7 Central Banks follow the mantra of data dependence. This will mean there will be no further rate cuts in the foreseeable future, with the Fed, BoE and ECB more likely to make their next move a rate hike. However, Jerome Powell made a slightly dovish statement yesterday about the future path of U.S. interest rates.

The foreign exchange market has not really seen the level of volatility seen in commodity markets since the war in Iran started. This is mostly due to the confused state of play, with some investors rushing to the dollar's haven status, while others see this as the beginning of the end of the dollar’s dominance.

Yesterday was yet another risk-off day, with dollar buyers in the ascendancy. This saw the pound fall to a low of 1.3252 and close at 1.3257.

The Federal Reserve kept its policy rate steady at 3.5% to 3.75% yesterday, once again refusing to bow to pressure from President Donald Trump to lower interest rates.

The move was not exactly out of the blue; recent economic indicators, including the sharp declines in GDP growth and inflation, have fuelled speculation that the Fed would continue its conservative approach to interest rates.

In its statement, the Fed highlighted that job gains have remained modest and that the unemployment rate has been little changed in recent months. The Central Bank also noted that inflation remains "somewhat elevated" and highlighted the uncertain implications for the U.S. economy of the war in the Middle East.

The Fed was widely expected to keep interest rates steady, according to most economists. The key point is that, with supply shocks related to the war in Iran, the bar for cuts has been raised.

The conflict in Iran has obscured the Fed’s commitment to its dual mandate of promoting employment growth while keeping inflation in check.

Even though oil prices have risen above $100, the President still called for interest rates to be cut. Kevin Warsh faces a tough challenge in resisting Trump’s demands if the conflict continues indefinitely, which currently seems probable.

Federal Reserve Chair Jerome Powell said he will not step down from the Fed Board until the ongoing investigation is complete, signalling his intention to remain in his role despite mounting scrutiny.

Powell emphasised the importance of letting the process run its course before making any decisions about his future.

The stance comes amid growing pressure in Washington for greater accountability at the Federal Reserve.

Critics contend that transparency is crucial for sustaining trust in financial institutions, while the situation adds to broader debates over the Central Bank's oversight and independence.

Independence and oversight have become confused since Trump returned to the White House.

The Fed is committed to transparency. However, it has the right to keep its monetary policy decisions independent. Interference from politics, not only at the Fed but also in most other Central Banks worldwide, must be avoided.

Trump believes he should have the final say on all decisions regarding interest rates, but observers see that as simply the thin end of the wedge and as a path to total political control.

The President’s former nominee to Head the Bureau of Labour Statistics has stated that the US economy is too fragile to withstand oil at $100 per barrel, warning of rising consumer prices caused by the war in Iran. “I don’t think this is an economy that is going to be able to handle $100 a barrel for oil, it’s just not,” EJ Antoni told the FT.

“The economy is weaker than we believed, and inflation is worse than we believed,” he added in a call yesterday, shortly before the Federal Reserve’s March rate-setting announcement. “The lower energy prices we saw in 2025 helped to put downward pressure on prices across the economy. Now, we will see higher energy prices have the opposite effect and put upward pressure on prices across the economy.”

The President appointed Antoni, the conservative Heritage Foundation’s chief economist, to lead the US labour statistics agency in August, soon after dismissing the previous commissioner over a bleak jobs report the President claimed was “rigged”. He unexpectedly withdrew Antoni’s nomination a month later and eventually selected government economist Brett Matsumoto, whose confirmation remains subject to Senate approval.

The dollar rallied yesterday as the conflict in Iran took another turn, following Israel’s attack on the South Pars gas field. It reached a high of 100.31 and closed at 100.29. The 100 level appears to be the “line in the sand for risk aversion.

Risk-on sees the dollar fall below that level, while risk-off sees it climb, although there remains strong interest in selling around the 100.50 level, as has been witnessed over the past few trading sessions.

Six weeks after its previous meeting, the ECB faces a markedly different situation today. The conflict in the Middle East has caused energy prices to rise sharply and has raised fears of a resurgence of inflation.

This context clearly brings to mind the year 2022. An energy crisis caused by a conflict was traumatic for Central Bankers, particularly at the ECB.

In 2022, they regarded inflation as "transitory", which led to a delay in rate hikes. This memory is especially painful at the ECB, where statements from various members of the Governing Council indicate they will not hesitate to act if inflation resurges.

But the ECB must remember that the situation is vastly different today. In 2022, interest rates were at zero, the economy was in a post-pandemic recovery, and the labour market was tight. All these factors contributed to the ongoing inflationary shock, but they are no longer evident in 2026.

Generally, economists believe that Central Banks should look beyond an energy shock and avoid overreacting. In other words, they should not panic and immediately raise rates when oil prices spike.

This was one of the ECB's best-known monetary policy mistakes. In July 2008, the ECB increased rates in response to rising oil prices. However, the subprime crisis was already underway, and the ECB eventually cut rates almost immediately.

It should be noted that rising energy prices not only exert an inflationary effect but also create a stagflationary shock: higher inflation and slower growth.

It is a fact that higher prices diminish demand. Ultimately, the effect on growth often becomes dominant.

According to a Bloomberg survey, most economists believe that the ECB will keep its interest rates steady until 2028. Markets, meanwhile, expect two rate hikes by the ECB in 2026.

To use an adage, differences of opinion are what “make a market.

Europe, Germany in particular, faces a quiet risk of stagflation, driven by persistent inflation and stagnant growth caused by energy supply shocks, deindustrialisation, and high labour costs. The combination of weak economic output, particularly in manufacturing, and high energy prices, worsened by geopolitical instability in the Middle East, resembles 1970s-style structural economic threats.

As evidenced this week by the release of Germany's ZEW index, confidence in the economy has swiftly faded.

It appears that Germany has become so accustomed to being the sick man of Europe that its business owners have grown defeatist in the face of economic challenges, rather than striving to overcome them, as the country once did when it led the region.

The Euro lost ground yesterday as the dollar reacted to the escalation of the conflict in Iran. It fell to a low of 1.1450 and closed at 1.1452.

Have a great day!