Donald Trump’s interim peace deal with Iran will offer only partial relief to the global economy, top central bankers have warned, as they told investors that they still face a fight to quash inflation.
Global policymakers remain on guard as inflation risks have failed to evaporate in the wake of the preliminary deal between Washington and Tehran, with energy prices still hovering above prewar levels and as demand surges in the US.
Bank of England governor Andrew Bailey warned this week that inflationary pressure was “in the pipeline”. The Bank’s Monetary Policy Committee held interest rates at 3.75 per cent on Thursday, but Bailey insisted he was ready to increase interest rates if inflation breaks upwards.
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A day earlier, Kevin Warsh, the new chair of the Federal Reserve, made it clear that battling inflation was his main priority, sparking speculation that a rate rise beyond the Fed’s current 3.5-3.75 per cent range could come as soon as next month.
The Fed is focused not just on the impact of higher petrol prices, but on an inflation problem that has proven worryingly persistent ever since the Covid-19 pandemic.
“Central bankers are not ready to call the all-clear — that is for sure,” said Luke Bartholomew, deputy chief economist at asset manager Aberdeen. He said the Iran agreement had removed a “massive tail risk” under which oil prices could have surged as high as $180 a barrel because of shortages, but this did not mean that inflation hazards had disappeared.
Oil prices retreated to about $76 a barrel after the deal, as traders bet on improved flows through the Strait of Hormuz, through which 20 per cent of the world’s oil and liquefied natural gas is normally exported. But futures prices have remained above levels that predated the hostilities, which began on February 28.
The conflict has helped drive other commodity prices higher, including fertiliser and metals, which are affecting broader supply chains. Analysts expect increases in food prices later this year because of the fertiliser shortages, with El Niño weather conditions adding to the risks.
“There is a growing recognition that the inflation pressures are broader than just energy,” said David Rees, head of global economics at Schroders.
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Even if the current ceasefire holds, analysts warn there will be delays in getting traffic flowing through the strait, while damage to oil and gas infrastructure will delay a return to prewar production levels. This could put a floor under energy prices, keeping inflation simmering.
While the fall in oil prices this week removes one of the primary drivers of higher headline inflation, in the US core price pressures — which strip out changes in energy and food — remain high.
The core personal consumption expenditures measure, which some Fed officials view as the best indicator of longer-term inflation pressures, was 3.3 per cent in April.
Forecasts published on Wednesday showed that officials believed core inflation would remain at that level for the rest of the year. The headline PCE figure, which the Fed uses for its 2 per cent target, is expected to end the year at 3.6 per cent.
Economists believe that if Warsh is as serious as he says he is about hitting the Fed’s 2 per cent inflation target, talk alone will not be enough and US borrowing costs will need to rise.
“If he wants to bring inflation down, the overwhelming likelihood is that he will have to raise rates,” said David Wilcox, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics. “We’ve had inflation above 2 per cent for an extended period of time and it’s a problem across a number of categories.”
Wilcox, who is also director of US economic research at Bloomberg Economics, added: “A plausible case has been made that if oil prices come down, if the tariffs pass through, the inflation problem will drift away. But the fact of the matter is that we’ve been trying to tell that story now for quite a while and it hasn’t come true.”
The BoE made it clear on Thursday that it did not believe inflation risks had subsided, even as the majority of its rate-setting committee opted to keep borrowing costs steady. Investors continue to price in the prospect of at least one rate increase before the end of the year.
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Other central banks also stress that they remain on guard.
The Reserve Bank of Australia kept rates steady at 4.35 per cent on Tuesday but warned global oil supply issues would take time to resolve. The Bank of Japan lifted rates to around 1 per cent and indicated the process of normalising borrowing costs had further to go.
Acting before news of the interim deal broke, the European Central Bank last week increased its benchmark interest rate by a quarter point to 2.25 per cent. Even under a milder scenario, where oil prices rapidly normalise, inflation will be close to 3 per cent this year, according to the ECB, above its 2 per cent target.
Concerns about the second-round inflationary impact from the conflict moved to the forefront of communications from the ECB and BoE in their recent meetings, according to a FT analysis, setting them apart from the Fed’s focus on domestic pressures.
The ECB dropped its reference to “well anchored” long-term inflation expectations from the introductory statement at its June press conference, abandoning language it had consistently used since the outbreak of the Iran war.
In minutes to its meeting this week the BoE likewise devoted significant attention to the risk that the energy shock could become “embedded” across the economy, making about two dozen references to second-round effects, evolving inflation expectations and the indirect impact of the conflict on inflation.
The heightened uncertainty created by the conflict also featured more prominently in the bank’s communications this month, with references roughly doubling since its first post-conflict meeting.
Additional reporting by Nic Fildes in Sydney
