The Iran war is reviving the global rate-hike threat

The Iran war has reignited concerns about a potential global interest rate-tightening cycle. As top central banks increase rates and hint at more potential hikes, inflation fueled by the conflict is causing concern. Key rates have already surpassed the historically low levels from the last tightening cycle that began in 2022. Central bankers are under pressure to show they are ready to raise rates further to control inflation and long-term bond yields at record highs.

The Bank of Japan became the latest major central bank to raise rates, following the Federal Reserve and European Central Bank's increases. The Bank of England left rates unchanged but indicated further action may be needed. This shift marks a stark contrast with the previous optimism following a brief US-Iran agreement. Instead, the collapse of that deal and recent Houthi advances in the Red Sea have changed the outlook, suggesting energy prices will remain higher for longer.

ECB Vice-President Boris Vujcic stated that if inflation remains high through autumn, it could dampen GDP growth, prompting future rate hikes on a meeting-by-meeting basis. Despite US President Donald Trump's call for rate cuts, new Fed Chair Kevin Warsh joined other officials in raising rates last week. This unanimous decision, along with Warsh's comments, signals the Fed's commitment to fighting inflation and reassures investors about its stance.

Fed projections indicate at least one more quarter-percentage-point hike by year-end, with many policymakers expecting further increases. While inflation is primarily driven by energy costs from the war, the BoE's governor noted that if the conflict persists, further rate hikes may become necessary.