Central Bankers Split on Inflation Tolerance as Iran War Drives Price Shocks

Michelle Bowman and other central bankers staked out opposing positions on inflation tolerance at a Reykjavík conference on May 29, as the Iran war drives energy prices higher and pushes inflation well above target across major economies.

Bowman, the Federal Reserve Vice Chair for Supervision, argued against raising interest rates in response to temporary energy-driven price surges, cautioning that such a move would unnecessarily harm economic activity and labor markets. She advocated a wait-and-see approach, saying it is too early to determine the long-term inflationary impact of the U.S. war in Iran. However, she warned that if disruptions persist into the second half of the year and drive broader price pressures, she would reconsider her stance. The PCE price index rose 3.8% in the 12 months through April. Her outlook aligns with new Fed Chair Kevin Warsh.

Bank of England Governor Andrew Bailey echoed Bowman's tolerance stance, stating that allowing inflation to temporarily exceed the 2% target is appropriate given economic weakness and uncertainty from the Iran conflict. The Bank of England held rates at 3.75% in April despite inflation reaching 2.8%. Bailey stressed that monetary policy cannot prevent higher energy prices from affecting households, though he warned this tolerance would weaken if second-round effects emerge.

By contrast, Kansas City Fed President Jeffrey Schmid and Fed Governor Christopher Waller took hawkish positions. Schmid called inflation the most pressing risk to the economy, noting it has exceeded 2% for over five years, and urged officials to signal firm commitment to price stability. Waller warned that persistent above-target inflation risks unanchoring future expectations. Market traders are now pricing in potential rate hikes late in the year.