Five Central Banks, One War, Two Answers

On May 29, in a conference room in Reykjavík, three officials from two central banks laid out positions that would become, seven weeks later, the world's monetary fault line. Fed Vice Chair Michelle Bowman said it was too early to gauge the economic effects of a war that had recently shut the Strait of Hormuz, and argued against raising rates for energy-driven price surges she saw as temporary. Bank of England Governor Andrew Bailey told the audience that tolerating inflation above target was appropriate because there was nothing monetary policy could do to stop higher energy prices from landing on households. Kansas City Fed President Jeffrey Schmid cut the other way, telling the room that inflation was too hot and had been above target for too long ^[1]. That was a debate about principles. By July it was a debate about rates, and the banks citing the war were importing its ceasefire rhythm into their decisions. The ECB tracked the cycle most visibly. When Hormuz was effectively closed by Iranian attacks in May, eurozone inflation hit 3.2%, with energy prices up nearly 11% ^[2]. The ECB responded on June 11 with its first hike since September 2023. Lagarde framed the decision as one that holds up across the range of paths the shock could follow, not pinned to a single forecast ^[2].

the war in the Middle East is generating inflationary pressures and the decision to raise interest rates appears robust against a range of scenarios, which map out how the shock could evolve and affect the medium-term outlook for the euro area — European Central Bank

Then the June ceasefire eased energy costs, and inflation dropped to 2.8% by July 1 ^[3]. Pressure on the ECB's next meeting dissipated, briefly. When the ceasefire collapsed on July 8, ECB policymaker Yannis Stournaras said the resumption of hostilities had put the inflation fight back where it started, and investors raised bets on two more hikes before year-end ^[4]. The Reserve Bank of New Zealand moved the same day, raising its cash rate to 2.5% — the first hike in over three years — with Governor Breman attributing the decision to the conflict's inflation fallout and warning the price shock risked becoming embedded ^[5].

Tolerate the war's inflation or hike against it

Tolerate: Fed's Bowman argued against hiking for energy-driven surges she saw as temporary; BoE's Bailey called tolerance appropriate, saying monetary policy cannot prevent higher energy prices ^[1]. Outcome: Fed held; BoE abandoned two planned cuts but did not hike ^[6][7].

Fight: KC Fed's Schmid demanded action against inflation he called too high for too long ^[1]. ECB hiked June 11 citing the war ^[2]; RBNZ hiked July 8 citing the war ^[5]; BoC held at 2.25% with inflation expectations at a four-year high, attributing the spike to energy prices from the Iran war ^[8].

The sharpest tension inside the divide belongs to Bailey. No central banker has attributed inflation to the war more explicitly.

The overshoot is almost entirely due to the conflict in the Gulf and it is quite likely that there will be more to come because there is naturally a delayed pass through. — Andrew Bailey

His Bank of England then abandoned two planned rate cuts but stopped short of raising, landing in an uneasy middle where the war is acknowledged as the dominant inflation driver but not chased with the tool that would fight it. The Fed's own June Beige Book — its regular survey of economic conditions — identified the Middle East as the main source of inflationary pressure, and May meeting minutes show nearly all participants flagged the risk the conflict could persist for an extended period ^[9]. Yet the Fed held. The Bank of Canada sat in a similar spot: inflation expectations at a four-year high in the second quarter, attributed to spiking energy prices from the war, and a hold at 2.25% ^[8]. Five banks, one diagnosis, two prescriptions. The financial market, meanwhile, has been pricing beyond the war — toward a future it assumes will be glutted, not scarce. Goldman forecast a 3-million-barrel-per-day surplus for 2027; the IEA projected 5 million ^[10][11]. Brent fell over $40 from its May peak to roughly $78 by mid-June. That bet rests on a ceasefire holding long enough for supply to return. Central banks are pricing the opposite: a present where Hormuz closures have already pushed energy costs into wages, expectations, and household budgets. When the ceasefire collapsed on July 8, Brent jumped 5% to about $80 ^[12], and the IEA warned the escalation could upend the surplus forecast.

An escalation in hostilities on 7-8 July, however, clouds the outlook and could upend the forecast that sees the market flipping to a surplus next year. — International Energy Agency

Central banks and oil markets are reading the same war in opposite directions. One sees a present shock that demands action; the other sees a future glut that justifies calm. The ceasefire that links them keeps breaking. The ECB meets July 22-23. ECB board member Isabel Schnabel is pushing for continued tightening even as oil falls, pointing to gas prices still about 40% above pre-war levels and core inflation that has not cooled ^[13]. If the ceasefire holds, the hawks may stand down. If it breaks again, the banks that chose tolerance will have to decide whether the shock they called temporary has become something else.