Heightened geopolitical tensions with Iran have caused a sharp rise in oil prices, intensifying pressure on central banks in the US, UK, and eurozone to combat inflation as millions of households face higher living costs.
As central banks in major economies weigh action on interest rates, households across the US, UK, and Europe are experiencing the effects of escalating energy prices and bracing for the possibility of increased borrowing costs, with inflationary pressures remaining stubbornly high.
Inflation threats driven by global energy shock
Rising hostilities in the US-Iran conflict have disrupted global oil and gas flows, especially through the vital Strait of Hormuz, resulting in Brent crude prices approaching $105 per barrel—a peak last observed at the initial stages of current unrest. As a consequence, consumers and businesses are feeling the squeeze: fuel costs at the pump have climbed, household budgets are under strain, and companies reliant on energy and transport services are passing those expenses onto customers, driving up the price of necessities like food and groceries.
This week, to address inflation, the European Central Bank (ECB) increased its main interest rate to 2.5%, warning that inflation is likely to “remain well above” its long-standing 2% inflation target for the foreseeable future. At the same time, the central banks of the US and UK are preparing their own pivotal interest rate decisions as markets grow anxious that enduring conflict might compound inflationary risks.
Federal Reserve and Bank of England consider policy shifts
The upcoming Wednesday meeting of the US Federal Reserve is widely anticipated as the first major central bank move. US rates have held steady within the 3.5% to 3.75% range for five meetings since the most recent shift—a rate cut in December. With inflation measured at 3.4% and labor market data remaining robust, many in the financial sector believe a rate hike is likely, particularly as President Donald Trump has indicated he does not expect any relief in oil prices until after the November elections and an end to the war with Iran.
Chair Kevin Warsh has remained cautious in his forward guidance but continues to stress the importance of reining in inflation, bolstering the argument for a possible rate increase. Deutsche Bank analysts have described a rate hike as “the most likely policy outcome,” based on statements from both Warsh and other Fed officials. However, expert opinions are divided; Grace Zwemmer of Oxford Economics sees no change in the immediate future, though few expect a rate cut. President Trump has also reiterated his call for lower rates, publicly encouraging the Federal Reserve to “get smart” following its recent leadership change.
The Bank of England will conduct its policy review next week as UK energy bills and gas prices—now above 200p per therm for the first time since the close of 2022—continue to rise. With inflation currently at 2.9% and likely to increase, the prevailing view among analysts is that the Bank will keep its rate at 3.75% for now. According to Oxford Economics, the absence of “second-round effects” such as extensive wage-driven inflation or large-scale business price hikes gives the Bank latitude for a measured approach.
Central bank strategies shaped by economic environment
KPMG’s chief economist Yael Selfin points out that the UK and most regions outside the US remain in a weaker economic position compared to the robust recovery seen in 2022, when UK inflation spiked to a record 11.1% in October. The legacy of high inflation and past rate hikes has also altered consumer behaviors, while the employment market has cooled significantly from its vigour four years ago. Alexander Harvey at Oxford Economics adds that businesses are cutting back on new hires and vacancy rates have dropped, which lowers employees’ ability to bargain for higher wages—easing the risk of a wage-price inflation cycle.
Markets, policy experts, and households will closely monitor the central banks’ coming rate actions, as these decisions and their accompanying economic projections will play a crucial role in shaping the near-term outlook for growth and inflation.
Additional reporting on household fuel costs is available at US prices remain high as fuel costs squeeze household budgets.